Casinos can, and here's how they should, significantly reduce their taxes through cost segregation

Casinos can significantly reduce their taxes through a process called cost segregation.

In fact, the process has become one of the most vital aspects of casino financing with tax consequences that can significantly add to a facility’s bottom line.

Under federal tax law, cost segregation consists of identifying personal property assets that are grouped with real property assets, then separating personal assets for tax reporting purposes.

To do this, one must hire an experienced engineer with a well-rounded understanding of construction finance, to produce a cost segregation analysis that identifies and classifies personal property assets so that depreciation time is dramatically truncated thus reducing one’s tax obligations.

Personal property consists of a building’s nonstructural elements, exterior land improvements, and indirect construction costs.

The engineer will examine all blueprints as well as architectural drawings, electrical plans, and isolate structural and mechanical components from those that are considered personal property. The cost segregation report also will identify architectural and engineering fees that can be segregated.

The report will identify “soft costs,” such as architectural and engineering fees, that are components of the building. A well-documented and thorough cost segregation analysis will do the following:
  • Maximize tax savings by adjusting the timing of deductions.
  • Create an audit trail to help resolve IRS inquiries. 
  • Take advantage of retroactive benefits.
  • Provide significant opportunities to reduce real estate tax liabilities.
The cost segregation study will identify building costs that would normally be depreciated over a 27.5 to 39-year period, then reclassify those costs, resulting in an accelerated method of depreciation. Such non-structural costs for such items as carpeting, wall coverings, some aspects of an electrical system, decorative lighting, indoor and outdoor plants, sidewalks, and landscaping, can all be depreciated  during the much shorter periods of five, seven or 15 years.

The larger tax deductions will result in increased cash flow and a lower cost of capital, especially during the first few years following an expansion project, renovation, or purchase. A cost segregation study can significantly help  identify opportunities for such periods of accelerated depreciation.  

For casinos to take full advantage of cost segregation opportunities, buildings must have been purchased, constructed, renovated or expanded after 1987. While cost segregation is cost effective for such new buildings, a well-done study can uncover tax deductions for buildings that pre date 1987. Also, buildings best suited for cost segregation should have a cost basis that is greater than $500,000.

In addition to providing tax relief, cost segregation can benefit casino owners and operators  in the these ways:

Maximizing tax savingsby adjusting the timing of deductions. When an asset’s life is shortened, depreciation expense is accelerated and tax payments are decreased during the early stages of a property’s life. This, in turn, releases cash for investment opportunities or current operating needs.

Creating an audit trail. Improper documentation of cost and asset classifications can lead to an unfavorable audit adjustment. A properly documented cost segregation helps resolve IRS inquiries early.

Playing Catch-Up:Since 1996, taxpayers can capture immediate retroactive savings on property added since 1987. Previous rules, which provided a four-year catch-up period for retroactive savings, have been amended to allow taxpayers to take the entire amount of the adjustment in the year the cost segregation is completed. This opportunity to recapture unrecognized depreciation in one year presents an opportunity to perform retroactive cost segregation analyses on older properties to increase cash flow in the current year.

Additional tax benefits:Cost segregation can also reveal opportunities to reduce real estate tax liabilities and identify certain sales and use tax savings opportunities.

Under certain circumstances, segregated assets may qualify for a special 30% bonus depreciation allowed by the Job Creation and Worker Assistance Act of 2002 or a 50% bonus depreciation allowed under the Jobs and Growth Tax Relief Reconciliation Act of 2003.

An example of cost segregation: Suppose an individual purchases a casino for $10 million while the land is owned by another entity. If the purchaser does not use cost segregation, then straight-line depreciation over 39 years must be used.

If, however, an engineer is retained and produces a report that shows that of the total price, $9 million should be for the building and $800,000 for a parking lot, and $50,000 for landscaping and shrubbery, the owner could save more than $100,000 assuming a tax rate of 35 percent and 5 percent discount rate.

Another example of the tax savings that can result from cost segregation is this: Suppose a cost segregation analysis shows that a building’s siding had an initial value of $200,000. Five years later, it has a value of $150,000 and must be replaced. The casino owner could deduct $150,000 as a loss. Without a cost segregation study, the owner could not take the deduction because the siding’s tax basis and the cost basis of the building would not have been itemized as separate entities.

Altogether, a cost segregation study is an essential fiduciary component when one does any of the following:
  • Builds a new casino,
  • Acquires an existing building,
  • Renovates an existing casino, or
  • Expands a casino.
Casino owners and operators who do not hire the appropriate experts to conduct a cost segregation analysis will fail to take advantage of significant tax benefits.