Get tax cash out of your real estate
Summer is almost officially over. Unfortunately, we’ll probably have a few weeks of heat left, but I’m ready for a little cooler weather. Hopefully you read this on the Sunday before the NFL season opens (Go Bucs!).
One of the most common questions I am asked is “What can I do to save taxes?” It is a very difficult question for me to answer. The real answer, which sounds a little sarcastic, is, “It depends.”
What does it depend on? It depends on your particular facts and circumstances. If your only W-2 income is your own (or not) your home and you don’t really have many other sources of income. If so, there isn’t much besides maximizing your 401k or IRA contributions (if you are eligible) to help you save on taxes.
However, if you own rental property, stock / bond investments, your own business (in a separate legal entity or not), or many other assets, there are many other options or options for you depending on what you want to do with your income and / or fortune.
One of these options is related to rental property. It is called a cost segregation study.
You might ask, “What is this Dan?”
Well, in a nutshell, it’s the cost of a rental property (also known as an expense through depreciation) and breaking that cost into a few different categories that allows for shorter tax periods to be depreciated.
“Say what ?! Why would I want to do this, or better yet, how do I do it?” You don’t. The reason you are doing this is to save some money on your taxes today instead of waiting really long.
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It would be best if I show you an example. Let’s say you buy a property that you want to rent out to a tenant. You’re buying this property for $ 500,000 (this works best on properties in excess of that amount due to the cost of study). If it’s a residential property, it will depreciate over 27.5 years (why says the IRS). If it is a commercial property, it is depreciated over 39 years. This is of course after peeling out a piece of land (which is not written off).
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Now suppose that for 27.5 years of depreciation, the annual depreciation expense is just over $ 18,000. But … when you do a cost separation study, a team of engineers will look at your blueprints and have formulas and legal proceedings that will allow them to break that $ 500,000 into smaller pieces. According to the study, engineers were able to say that $ 350,000 is 27.5 years, $ 50,000 is 15 years, $ 25,000 is 7 years, and $ 75,000 is land. Your depreciation for the 27.5 year old property will decrease, but the depreciation for the seven and 15 year old property will increase sharply due to the special depreciation rules for five, seven and 15 year old assets. Depending on when you bought the property, this can be a huge tax deduction. But please make sure that you can deduct your rental losses, otherwise this would be a wasted effort.
The good news is that you can always conduct a cost separation study for your property. Yes, even if you bought it 10 or 15 years ago. You get all of the depreciation that you should have taken in the year you did the study (i.e. today).
As I mentioned earlier, a cost segregation study works best on properties that are generally over $ 500,000, which are more likely to be commercial real estate or larger apartment buildings, but they can work for smaller residential properties.
If you would like to know more please contact my office and I will be happy to give you a recommendation on a company that can do a feasibility study to make sure it works for you. As always, please contact a licensed tax advisor who will assist you with this.
See you next month, stay cool.
Dan Henn, CPA, is a local accountant. His firm specializes in IRS auditing and debt collection agency, real estate and medical taxation, year round tax planning and tax preparation in Rockledge. You can contact his office at 321-684-7800 or [email protected].