Tax Deductions (Two Seldom Used Tips for Real Estate Owners)
Tax deductions are significant because they reduce taxable income, thus indirectly reducing federal income taxes. Tax deductions do not directly reduce federal income taxes. (Tax credits, such as the low-income housing tax credit program, directly reduce federal income taxes.) For example, increasing tax deductions by $100,000, for someone in the 35% tax bracket, would reduce their federal income taxes by $35,000 ($100,000 X 35%). This article reviews real estate depreciation and casualty losses as options for increasing tax deductions.
Depreciation is the primary non-cash source of tax deductions for real estate owners. Most tax deductions require a cash expenditure for items such as labor, materials, vendors and utilities. Depreciation is a tax deduction that does not require a cash expenditure that is available to encourage real estate ownership and investment.
Limited work and analysis is used to establish most depreciation schedules. This is a serious oversight. It is possible to sharply increase depreciation (in the first 5-7 years of ownership) and increase tax deductions by using a process called cost segregation to fine tune the depreciation schedule. Simply separating land from improvements is the process used to determine most depreciation schedules. This is analogous to using kerosene as fuel in a Ferrari. Cost segregation precisely separates up to 130 building components in a lawful manner. These short-life components can be depreciated over 5, 7, or 15 years (versus 39 years for commercial properties and 27.5 years for residential rental properties) and the depreciation is used as tax deductions.
You can claim a one-time tax deduction windfall by catching up depreciation after obtaining a cost segregation study. This process allows you to reclaim (in the current year) previously under-stated depreciation (without filing any amended federal income tax returns).
Casualty losses offer bountiful tax deductions that are seldom claimed. You are allowed to take a casualty loss (which is a tax deduction) for the value of the property immediately before the casualty and the value immediately after the casualty less the portion covered by insurance. Consider the following example: A two-story, 200-unity apartment complex near the Florida Gulf Coast is flooded with 1 foot of water following a major hurricane. The cost of physical repairs is $1 million and is covered by insurance. However, it will take about 12-18 months to complete repairs (due to shortage of contractors in the area) and there is no business interruption or “lost rents” insurance. Following is an estimate of value immediately after the hurricane:
| Value before Hurricane |
6,000,000 |
| Physical repairs |
- 1,000,000 |
| Construction Management Fee |
- 100,000 |
| Lost Rent |
- 900,000 |
| Entrepreneurial Effort |
- 600,000 |
| Value After Hurricane |
2,400,000 |
The casualty loss is $2.4 million ($6.0 million (value before) - $3.4 million (value after) - $1.0 million (covered insurance)). Based on 35% tax rate, this tax deduction generates over $800,000 in year one federal income tax savings!
The shock of a major casualty is horrendous; a tax deduction can be the silver lining. Both real estate depreciation and casualty losses are under-utilized opportunities for tax deductions.
Click here for a FREE preliminary analysis of income tax savings for your property.
Cost segregation produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of cities where cost segregation generates meaningful tax deductions.
City:
- Boston, MA
- Hartford, CT
- Baltimore, MD
- Los Angeles, CA
- New York, NY
- San Francisco, CA
- Bridgeport, CT
- Houston, TX
- Philadelphia, PA
- New Orleans, LA
- Louisville, KY
- Santa Rosa, CA
- Little Rock, AR
- Charlotte, NC
- Albuquerque, NM
- Madison, WI
- Albany, NY
- Sacramento, CA
- Greensboro, NC
- Knoxville, TN
- Virginia Beach, VA
- Ft. Lauderdale, FL
- McAllen, TX
- Tucson, AZ
- New Haven, CT
- Chicago, IL
- El Paso, TX
- Detroit, MI
- Pittsburgh, PA
- Austin, TX
Cost segregation produces tax deductions for virtually all property types, including the following:
Property Type:
- Funeral home
- Commercial building
- Student housing
- Retail
- Power center
- Amusement park
- Auto salvage yard
- Office warehouse
- Medical facility
- Daycare center
Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.
Industry:
- Golf courses and country clubs
- Leather product manufacturing
- Textile mills
- Beverage and tobacco product manufacturing
- Real estate lesser
- Arts, Entertainment, and Recreation
- Machinery manufacturing
- Laundry facilities
- Apparel manufacturing
- Frozen food manufacturing
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