Healthcare facilities can unlock hidden money with tax breaks

By Lloyd F. Sweet, Jr., CPA, Healthcare Tax Partner, Gordon, Hughes & Banks, LLP

After years of stagnation during the 1990s, the healthcare construction industry in Colorado is making a comeback. Despite Colorado’s high quality of life and its reputation as a preferred relocation center, healthcare facilities in the previous decade did not keep pace with the expanding metropolitan populations throughout the State.

As young families move to metropolitan and suburban Denver, and as baby boomers and retirees seek quality of life over big city living, population centers in Denver, Colorado Springs, along the I-70 corridor and the Western Slope have seen a surge in hospital construction and accompanying ambulatory and primary care clinics in response to changing demographics and population growth. Second-home owner demographics are impacting the success of planned and existing communities as affluent retirees move to the high country as permanent residents. This growing, retired population is fueling the demand for expanded hospital beds, geriatric facilities and specialists in geriatrics, cardiology and internal medicine.

With the surge in construction and renovation of healthcare facilities, a tax tool known as cost segregation can create a huge cash-flow advantage for owners by identifying, accumulating, separating and reclassifying part of the building as equipment. This accelerates the depreciation over five, seven or fifteen years, which is the standard for personal property, rather than the standard 39 years for buildings.

Cost segregation for healthcare facilities is not a new idea, yet real estate owners are often confused about what a cost segregation study really is and how they can receive maximum benefits from the procedure. Cost segregation basically identifies those costs hidden in a building that actually represent non-building assets. A cost segregation engineer will typically review construction invoices and building plans to determine which assets can be allocated to five-, seven- or fifteen- year assets. An on-site inspection follows to collect additional information, and the exterior and interior of the building are photographed. The engineer will allocate material components, direct labor and indirect costs using industry-standard construction cost data, and calculate often-ignored items such as wire, nails, screws and a portion of the contractor’s overhead which can also be depreciated over a much shorter life. The engineer then creates a written report detailing the findings and cost allocations, with appropriate references and rulings to support positions taken. The engineer helps the owner file the report with the annual tax return and will represent the owner in the event that any cost segregation decisions result in an audit.

Examples of assets within a project that can qualify include equipment, office furniture and fixtures, landscaping, land improvements, floor coverings and specialty electrical and HVAC equipment. Decisions as to what can be segregated are based on sound engineering principles that are supported by IRS regulations, rulings and case law. For example, medical and dental offices have specialized wiring, built-in improvements for treatment rooms and possibly special shielding for X-ray rooms. The building may have internal wiring and cabling for data transmission.

In addition to new construction projects and building acquisition, this methodology applies to owners who have either constructed or acquired buildings in prior years. An owner is allowed to reclassify these types of assets by making an accounting method change and recognizing the entire “catch-up” amount in the year of the change. It is never too late to correct the books, even if an owner has overlooked cost segregation in the past (unless the building is fully depreciated).

For-profit hospitals, medical and dental offices, nursing homes, skilled nursing homes and assisted-living facilities are ideal subjects for a cost segregation study. Under certain circumstances, and in certain states, not-for-profit facilities are allowed a gross receipts tax exemption for personal property.

A cost segregation study may be beneficial if the cost of a structure (land excluded) is at least $500,000; the purchase, construction or renovation has taken place in the past seven years; and the owner plans to retain the property for several years and currently has taxable net income.

Examples of the following healthcare facilities illustrate the potential benefits of a cost segregation study:

• • A $3.2 million medical clinic located in a renovated grocery store had a first year increase in cash flow of $48,600 with NPV (net present value) of accelerated cash flow of $149,000.
• • A $2.1 million newly constructed ambulatory facility achieved a first year increase in cash flow of $26,000 with NPV of accelerated cash flow of $72,400.
• • Finally, a $6.3 million newly constructed retirement facility with onsite healthcare facilities had a first-year increase in cash flow of $100,300 with NPV of accelerated cash flow of $261,800.

Each building is unique, and the amount of reclassification varies, so it is best to consult a professional. The IRS recently issued guidance for tax auditors to use in reviewing cost segregation studies. While no specific credentials are required, the IRS states that a study by a construction engineer is more reliable than one conducted by an individual with no engineering or construction background. In addition, experience in cost estimating, allocation, and knowledge of the applicable law is also important. Real estate owners of healthcare facilities owe it to themselves to look into this proven value-added benefit.