In recent years, franchised car dealers have invested significant capital in their retail facilities. This trend will continue for years to come. Dealers should be mindful of the tax treatment afforded to these investments. In certain situations, dealers can utilize tax strategies to reduce their current federal tax liabilities. This article provides some background on the rules and some strategies to minimize dealer tax liabilities.
Qualified Retail Improvement Property – Last year, the “Protecting Americans from Tax Hikes Act of 2015” (PATH Act) became law. This new law made permanent the provisions for “Qualified Retail Improvement Property” (QRI Property). QRI Property provides tax benefits to automobile dealers for investments in their facilities. Improvements to showroom facilities that meet the following criteria would qualify as QRI Property and thus the expanded tax benefit:
- Improvements made to interior retail space. This space needs to be open to the general public and used for selling personal property, and
- Improvements made to a facility more than three years after the building was first placed in service. (Thus, improvements made to a brand new facility would not qualify.)
The following items are expressly prohibited from meeting the definition of QRI Property:
- Costs to enlarge the building,
- Elevators and escalators,
- Internal structural components,
- Structural components benefitting common space.
Renovations that meet the definition of QRI Property are eligible for a shorter depreciable life of 15 years (this is good), bonus depreciation (this is better) and Section 179 expense deduction (this is best). Prior to the permanent extension of QRI Property, these capital improvements would have to be depreciated over 39 years. As an example, a dealer makes improvements to his or her showroom at a cost of $400,000. If the improvements qualify under the QRI Property definition, the dealer can potentially take a current deduction for the full $400,000. If the improvement does not meet the criteria, the dealer could potentially only be eligible for $10,256 in current year depreciation deductions. (This deduction would be taken each year for the next 39 years.) This would provide the dealer a significant tax savings in the year when the improvements are made.
To ensure that a dealer maximizes his or her ability to utilize the QRI Property rules, here are two quick strategies that dealers should consider when making capital investments in their facilities:
- Use Operating Company for Improvements – A dealer should use their operating company to incur the cost of improvements to the showroom. The alternative would be for the real estate entity to incur these costs. The Section 179 expense deduction allows dealers to expense up to $500,000 per year of new and used property purchases. However, Section 179 is generally not allowed for rental real estate entities. As such, a dealer cannot utilize Section 179 if the retail improvements are done by its real estate entity. If the improvements are made by the operating company, the dealer should be able to utilize the full amount of Section 179 to expense the improvements.
- Cost Segregation – In situations where the dealer is making improvements both to his or her showroom as well as to the back office and service area, the ability to differentiate the cost of these improvements might be difficult. The inability to differentiate costs would preclude the dealer from maximizing the benefits of the QRI Property rules. In these situations, it will likely make sense for the dealer to perform a cost segregation study. A cost segregation study, performed by a qualified person, will allocate an appropriate amount of your investment to QRI Property, and allow you for a maximum current tax deduction.
If you have any questions, please contact Paul McGovern at pmcgovern@downeycocpa.com or 800-849-6022.
