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.

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Eco-Friendly Practices: Corporate Social Responsibility

The hotel industry has undertaken a long-term effort to build more responsible and socially conscious businesses. What began with small efforts to reduce waste - such as paperless checkouts and refillable soap dispensers - has evolved into an international movement toward implementing sustainable development practices. In addition to establishing themselves as good corporate citizens, adopting eco-friendly practices is sound business for hotels. According to a recent report from Deloitte, 95% of business travelers believe the hotel industry should be undertaking “green” initiatives, and Millennials are twice as likely to support brands with strong management of environmental and social issues. Given these conclusions, hotels are continuing to innovate in the areas of environmental sustainability. For example, one leading hotel chain has designed special elevators that collect kinetic energy from the moving lift and in the process, they have reduced their energy consumption by 50%  over conventional elevators. Also, they installed an advanced air conditioning system which employs a magnetic mechanical system that makes them more energy efficient. Other hotels are installing Intelligent Building Systems which monitor and control temperatures in rooms, common areas and swimming pools, as well as ventilation and cold water systems. Some hotels are installing Electric Vehicle charging stations, planting rooftop gardens, implementing stringent recycling programs, and insisting on the use of biodegradable materials. Another trend is the creation of Green Teams within a hotel's operation that are tasked to implement earth-friendly practices and manage budgets for green projects. Some hotels have even gone so far as to curtail or eliminate room service, believing that keeping the kitchen open 24/7 isn't terribly sustainable. The May issue of the Hotel Business Review will document what some hotels are doing to integrate sustainable practices into their operations and how they are benefiting from them.