This week, our blog is going to share a real-life example about the hidden cost of hiring the wrong CPA for your small business accounting and tax needs.
In our prior blog, 5 Signs Your Current CPA is No Longer The Right Fit for You, we mentioned that one of the biggest challenges your current CPA has (along with most of the ones you may hire) is that they are only focused on the past. It’s easy to get stuck in that reactionary tunnel vision when you’re facing deadline after deadline and don’t have the most effective accounting systems.
Another point we mentioned in that blog is that selecting the lowest cost provider for small business accounting and tax work may not always be the best decision. Most often, cheaper isn’t better, especially if the bookkeeper is cutting corners in your accounting work or the CPA isn’t staying up to date on the more advanced tax planning strategies.
A Case Study: $100k
A new client that recently hired us faced both challenges with their current CPA; we decided to share their story to give some insight into the hidden cost of hiring the wrong small business advisor.
When this new client came to us at end of 2023, they had just completed a 2-year building purchase and renovation project that began in 2021. The previous CPA completed the 2021 and 2022 returns that coincided with the initial years of the project.
The new client was concerned their current CPA might not have performed the accounting work correctly. They also thought this CPA was charging them too much for their work.
After our initial pass through this client’s prior year tax returns, we saw that this CPA was not overcharging this client but was actually undercharging under the market rate relative to the amount of work that needed to be performed.
If you’ve ever been involved in a building project, you know that the one fundamental principle for all building projects is that they are going to take longer and cost more than you expect. The new client’s project followed a similar path, which left them scrambling to cover the cost overruns with several sources of additional funds including personal cash, personal credit cards, and business credit cards.
Accounting for construction projects can get complicated. The work is even more complicated once the client is using additional funding sources outside the entity that owns the building. Once this situation arises, the a series of transactions happening outside the normal books must be captured and reflected in the entity’s accounting records.
The combination of complicated accounting work with a lower cost provider produced a bad outcome for this client. The prior accountant had not recorded most of the personal spending on the building, had left 3 business credit cards off the books, and had incorrectly booked an $82,000 construction loan draw. At the end of 2022, the construction in progress balance on the 2022 tax return was understated by over $100,000 because of these mistakes.
If we hadn’t found and corrected these errors, our new client would have lost over $100,000 in depreciation deductions over the life of the building. Additionally, if/when they sold the building, they would have overstated their capital gains since the building’s cost basis was understated. The missed depreciation would have cost them over $25,000 in additional income taxes paid in future years while the understated basis could have cost them another $15,000-20,000 in taxes when they sold the building.
One of the biggest challenges with buying / building a commercial building is the long 39-year depreciation life that the IRS requires you to assign to the building. This 39-year life means that the cost deduction for owning the building happens equally over 39 years, creating a huge mismatch between when you spend the cash and when you get the deduction. Framing the situation another way, with a 39-year life, you get to deduct ~2.5% of the cost of the building every year, for 39 years. Giving an example of the math – a $1,000,000 building will only generate a roughly $25,000 deprecation deduction every full year. That’s not much of a yearly deduction for spending $1,000,000 of your money.
Standard Accounting vs Proactive Accounting
If your accountant isn’t being proactive and just keeps her head down on her work, she’s going to follow the standard path of accounting for your building. That path allocates a % of your building to land and the rest is allocated to the building. In our hypothetical example, $100,000 of the $1,000,000 total cost is allocated to land, with the $900,000 remaining allocated to your building. In the first full year you own this building, your depreciation deduction would be $23,000.
There’s nothing wrong with this approach since it follows the IRS’ rules, but is it maximizing the benefit to you?
This situation is another example of a hidden cost of working with the wrong accountant – instead of following the standard path, the right accountant takes the time to put his pencil down, look up, and be proactive.
A proactive accountant knows there are options available for building accounting that may help get you out of some of this 39-year depreciation trap.
There are experts that can perform cost studies on your building projects – these studies produce engineering and cost segregation reports that are accepted by the IRS and can be used to move portions of your building cost out of the 39-year bucket and into asset classes that are depreciated over a much shorter time span of 5-15 years. Getting costs into shorter-life assets get more depreciation deductions sooner, generating tax savings in the earlier years when you need it the most – when you’ve spending your cash on the building project.
Our new client’s former accountant had never mentioned the option for a cost segregation study. If our client had remained with this CPA, they would have paid a high hidden cost for their decision.
Once we corrected the accounting, our client’s total spend on their building was a little over $1.1 million. After allocating the portion of the cost for the land, our client’s 2023 depreciation deduction using the 39-year building asset class would have been $8,300 for the initial partial year deduction.
Based on our recommendation, our new client hired one of our third-party partners to perform an engineering study for their building.
After we booked the impact of the engineering study into their fixed asset records, our client’s 2023 depreciation deduction was almost $407,000, which was nearly $399,000 higher than the amount would have been from using the standard approach.
This accelerated depreciation deduction will lead to $105,000 in reduced taxes on the owners’ 2023, 2024, and 2025 tax returns.
The $105,000 in savings we were able to produce for this new client is a perfect example of the hidden costs of working with the wrong small business accountant and the real benefits you gain by working with the right CPA.
At Diamant Accounting, we work collaboratively with our clients to help them end the financial chaos in their business, save on taxes, and proactively look for opportunities to grow their business. We provide innovative technology and accounting solutions along with Fortune-500 caliber insights to our small business clients using a small team and a high-touch, in the trenches approach. We’re as comfortable talking with car mechanics as we are with CEOs.
Contact us today for more information about how we can help your business.
