Cost segregation is a proven tax planning strategy that the cannabis industry can use to cut down on their income tax liability. For decades, the IRS has challenged this strategy in tax courts, but it’s been upheld time and time again. Although cost segregation is permitted under IRC 280E, very few business owners know about it.
What is the Formal Definition of Cost Segregation?
As defined under the Internal Revenue Code 280E, cost segregation is, “the process of identifying personal property assets that are grouped with real property assets and then reallocating those personal property assets for federal tax reporting purposes.”
Simply stated, cost segregation is a method your cannabis company can apply to claim more deductions on your tax return.
How Does Cost Segregation Benefit Cannabis Companies?
To benefit from this tax savings tool, you need to identify your personal property assets that are currently classified as real estate property. They’ll then need to be re-allocated to personal tangible property.
Re-allocating your assets gives you the benefit of depreciating them faster because depreciation time for personal tangible assets could be five, seven or 15 years. And this is significantly faster than the depreciation time for real estate assets, which can be 20 to 39.5 years.
This tax planning strategy means you can maximize your depreciation deductions much sooner.
What Types of Costs Qualify for Cost Segregation?
Operating expenses that may qualify for cost segregation include:
- Task-specific lighting costs, such as your grow lights
- Costs paid to operate your electrical, plumbing and security systems
- Specialty systems used for achieving climate control
- Expenses incurred to run your hydroponic and irrigation systems
Many of the costs spent on the build-out and operation of your cannabis business qualify for savings under this tax strategy.
What Kind of Buildings Qualify?
If your commercial, rental, or lease-hold building meets the following criteria, it can qualify for cost segregation:
- Your building is currently being used in the operation of your business
- Your building was acquired
- You built internal structures that serve as grow rooms or inventory rooms
- You made updates and improvements to the building
The two most important points are: your building is in service and you’ve taken ownership of the building (as the purchaser, leaseholder, etc.)
What is the Largest Potential Tax Savings?
Cannabis companies who use cost segregation to reduce their taxes can write-off anywhere from 18 to 30 percent of their facility expenses. This can translate to hundreds of thousands of dollars saved during the early years of operation.
How Much can my Cannabis Company Save?
To get an estimate of your company’s potential tax savings, it’s advised to consult a team of accounting professionals and cannabis tax experts, like the ones from Northstar Financial Consulting Group. A qualified, outsourced CFO understands what is needed to execute a proper cost segregation study. And they know which supporting documents and evidence are required for the IRS.
Examples of items needed to conduct a compliant cost segregation study include:
- The address of your building
- The in-service date of your building
- The purchase price, less land
- Cost of improvements made (if any)
- Service date of your improvements, which appear on your Fixed Asset Schedule (FAS)
- Square footage of asset(s)
- Federal marginal tax rate and more
Fortunately, a cost segregation study doesn’t require an accountant to prepare an amended tax return. When your accountant completes the study, they submit a form and the necessary documentation to the IRS. This form captures an accurate depreciation figure, so you can receive the benefit of this tax savings tool.
Cannabis companies go years without ever benefiting from these deductions. Plus, many accountants and tax preparers aren’t aware of cost segregation as a tax tool.
Cost segregation is a strategy that can save your company thousands of dollars while maintaining 280E compliance. So, take advantage of this money-saving strategy by contacting Northstar at (424) 274-3188 or firstname.lastname@example.org.