Tax Deductions: Understanding Renovations and Improvements
By Marky Moore Founder, Capital Review Group | February 05, 2012
The hospitality industry has never been more competitive than it is today, as hotel owners face consumers' increasingly high standards and reduced travel budgets, as well as increased operating and construction costs. To survive in the industry today, it's essential to understand the tax strategies that result in increased cash flow and can actually provide funding for renovations, improvements, and energy efficiency upgrades. Understanding the tax opportunities that are currently available will allow you to develop a comprehensive plan for improvements that makes financial sense and allows you to maintain a property that offers everything today's consumer demands.
Hotel owners face some unique challenges in maintaining a financially viable business. There are building maintenance and renovation concerns, interior furnishings and often extensive exterior elements to oversee, as well as day to day operations, staffing and customer service. Hotel owners looking at a "big picture" scenario of saving money through energy efficiency have to consider the cost of making the necessary improvements to the property. You might want to retrofit your existing hotel property with energy efficient lighting, HVAC or upgrades to the building envelope in order to save money on energy costs, but you've first got to come up with the funding for those improvements. Do you provide the required capital or continue to face increased operating costs?
The ROI on new, energy-efficient systems may take longer, but the equipment will perform more reliably while providing better working conditions and lowering energy costs along the way. Most hotel owners will assume that funding for energy efficient upgrades has to come from dipping into their equity in the facility, or from an outside funding source such as a bank loan. The good news is that hotel owners can take advantage of targeted tax and energy strategies that can significantly increase operating cash flow and generate a substantial ROI, as well as funding energy efficiency projects through a significantly lowered tax burden.
A review of the real property assets may identify tangible personal property reducing the class lives to five, seven and 15 years for taxation purposes, which reduces current income tax obligations. Personal property assets include a building's non-structural elements, exterior land improvements and indirect construction costs. Although the list is long, a few examples of items that can be reclassified include cabinetry, decorative millwork and lighting, some types of flooring and wall coverings, and specialty electrical and plumbing. Hotels can typically benefit from this strategy because they contain large amounts of personal property in guest rooms, restaurants, and conference facilities. Exterior features such as paving, fencing, sidewalks and lighting are also eligible. When these assets' lives are shortened, depreciation expense is accelerated and tax payments are decreased, which frees up cash for other uses.
The ideal time to initiate this strategy is during the planning phase of building a new property, remodeling or expanding an existing building. At this time, project-related costs that qualify for a shorter depreciable life can be identified, segregated and reclassified as they are incurred, instead of waiting until the project is completed. For capital construction projects and newly acquired buildings, an accurate assignment of costs will allow a taxpayer to "front load" cost recovery and cash flow, maximizing them in the immediate years following the construction or purchase.
However, the benefits of this strategy may be are retroactive, including buildings that have been purchased, constructed, expanded or remodeled since 1987. This allows taxpayers to bring forward previously unrecognized depreciation, which can significantly increase cash flow in the current year.