Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / How Franchisees Save Thousands with Cost Segregation Studies
Transcript
- Lucas: I was looking at the tax return of a franchisee who owns three quick-service restaurant units, and in year one of a new location, they saved forty-seven thousand dollars in federal taxes. Not by selling more sandwiches — by the way they classified their construction costs. Luna: Forty-seven thousand? That sounds like a tax loophole. But is it legal? Lucas: Completely legal. It's called a cost segregation study, and it's one of the most underused tools in franchise finance. Basically, instead of depreciating the entire building over thirty-nine years, you break out components like electrical, plumbing, flooring, even landscaping, and depreciate them over five, seven, or fifteen years. That front-loads your deductions. Luna: And if today's example sparked an idea for your own business, that's exactly why we do these deep dives. Cost segregation isn't sexy, but it puts real money back in your pocket. The way we keep this show going without ads is listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. Lucas: Exactly. Just a small gesture helps us stay independent and focused on content like this. So — let's unpack how cost segregation actually works for a franchisee. Luna: When would a franchisee even consider this? Is it just for people who own the building? Lucas: Good question. If you own the real estate, yes, you're an obvious candidate. But even if you lease, you can still benefit. Leasehold improvements — the build-out the franchise requires — are considered tangible personal property in many cases. Think about it: a typical fast-casual franchise build-out for a single unit runs between three hundred fifty thousand and six hundred thousand dollars. That's not just drywall and paint. It includes specialized kitchen equipment, point of sale systems, HVAC systems, walk-in coolers. A cost segregation study unpacks those costs. Luna: So instead of writing off the whole build-out over the lease term or thirty-nine years, you can write off the equipment portion much faster. Lucas: Right. The IRS allows certain assets to be depreciated over five, seven, or fifteen years. The trick is identifying which costs qualify. That's where the study comes in. A qualified engineer or tax professional reviews construction blueprints, invoices, and apportions the costs. Typical results show that about twenty to forty percent of a building's cost can be reclassified to shorter-lived assets. For that franchisee I mentioned, with three units, the combined reclassified amount was around four hundred thousand dollars. At a combined federal and state tax rate of roughly thirty percent, that's a hundred twenty thousand in tax savings spread over the first few years, with the bulk in year one. Luna: And the cost of the study itself? Lucas: For a single location, expect to pay between three thousand and five thousand dollars. For a multi-unit franchisee, maybe eight to twelve thousand. The IRS has specific rules, but the study is completely defensible if done properly. In fact, the IRS has issued guidelines — Audit Techniques Guide for Cost Segregation — so it's not a gray area. It's a well-established strategy. Luna: So let's say a franchisee is opening their first unit next quarter. When should they do this study? Lucas: Ideally before the building is placed in service, meaning before you open for business. If you already opened, you can still do a look-back study and file an accounting method change with IRS Form 3115. But the sooner, the better. The time value of money is real: a dollar saved this year is worth more than a dollar saved in ten years. Luna: Are there any downsides? What about bonus depreciation or Section 179? Lucas: Actually, cost segregation plays very nicely with bonus depreciation. For qualified property placed in service after 2023, bonus depreciation is being phased down — it's at sixty percent for 2024, forty for 2025, twenty for 2026, and then zero in 2027 unless Congress extends it. But as of mid-2026, we're at forty percent bonus for new assets. So combined with cost segregation, a franchisee can accelerate even more. Section 179 allows you to expense up to a certain limit, but it's limited to taxable income. The beauty of cost segregation is that it's not just about the first year — it creates a schedule of higher deductions over the first five to fifteen years. Luna: So what happens when you sell the franchise? Do you have to recapture all that depreciation? Lucas: Yes, at sale, you'll face depreciation recapture — taxed as ordinary income up to the depreciation taken. But that's years down the road, and in the meantime you've had the use of that money. Plus, if you hold the property for more than a year, the gain above the adjusted basis is taxed as capital gains, which typically has lower rates. So it's a net positive strategy. Luna: Any real-world cautionary tales? I remember a franchisee in the Midwest who did a cost segregation study but didn't realize that certain items like landscaping only qualify if they're not part of the building structure. Lucas: That's a common mistake. Land improvements like parking lots, sidewalks, and fences are fifteen-year property, not five. And internal components like electrical that serve the entire building may still be thirty-nine-year property if they're structural. That's why you need a professional who understands tax law, not just a contractor estimating costs. Bad studies can trigger audits. But a quality study from a reputable firm — especially one that provides a cost segregation study report that follows IRS guidelines — will hold up. Luna: What about franchisees who are still paying off debt? Could the tax savings be used to pay down loans faster? Lucas: Absolutely. That's one of the most common uses. The extra cash flow from reduced tax payments can go directly to principal reduction. Or it can fund the next unit. I know a franchisee who used the savings from a cost segregation study on their first unit to pay for the down payment on their second unit. It's like a self-reinforcing growth engine. Luna: So for a franchisee listening right now, what's the first step? Lucas: Talk to your CPA or tax advisor. If they're not familiar with cost segregation, ask them to research it or refer you to a specialist. Then get a quote from a firm that does cost segregation studies — many offer a free preliminary analysis. They'll look at your building costs and give you a rough estimate of potential reclassification. Then run the numbers: if the tax savings in just the first year exceed the cost of the study, it's a no-brainer. Luna: And if you're a multi-unit franchisee, you might want to bundle multiple properties into one study for efficiency. Lucas: Exactly. Some firms will do a portfolio study for a flat fee. Also, keep in mind that cost segregation isn't just for new builds. You can do a retroactive study on a property you've owned for years. You catch up missed depreciation in a single year through a change in accounting method — no amended returns needed. So even if you've been operating for five years, it's not too late. Luna: I think the real message here is that franchisees need to think of their tax strategy as a lever for growth, not just a compliance chore. Lucas: Exactly right. And cost segregation is just one lever. We'll cover others in future episodes — things like like-kind exchanges, opportunity zone investments, and entity structuring. But for today, if you're a franchisee with real estate or significant leasehold improvements, cost segregation might be the quickest hundred thousand dollar decision you never knew you had. Luna: I can already think of a few franchisee friends who'd want to hear this. Lucas: Share the episode with them. And as always, thanks for spending part of your day with us. We'll see you next time on Franchise Conversations. Luna: Take care.