Income Taxes too high? (Depreciation Tax Tips)
Income taxes are a painful reality of life. Surprisingly, many wealthy individuals unknowingly overpay federal income taxes because they are unaware of tax deductions. Real estate investors often overpay income taxes because they do not correctly calculate depreciation, inappropriately capitalizing operating expenses and capitalizing equipment purchases which could be the expensed. This article reviews options for reducing income taxes by increasing deductions.
Income taxes can be cut sharply by correctly depreciating real estate. Depreciation is a non-cash expense. Most real estate depreciation schedules are established by splitting the cost basis between land and long life property. For real estate investors who have a meaningful income tax burden, this approach is inappropriate. Rental residential real estate is depreciated over 27.5 years and commercial property is depreciated over 39 years. A significant portion of real estate can be categorized as short-lived property. Short-life property can be depreciated over 5, 7 or 15 years. A cost segregation analysis performed by an appraiser can typically allocate 20% to 40% of the cost basis (of the improvements) to short-life items. This allows the owner to increase depreciation by 50% to 100% during the first five to seven years of ownership. In addition, it is possible to "catch-up” depreciation which has been underreported in prior years.
Income taxes can also be reduced by differentiating between capital expenditures and operating expenses. Consider the following examples:
1) An apartment owner discovers extensive rotten wood on a building. Upon further examination, he realizes it is necessary to replace approximately 20% of the exterior wood on a building. The building was painted two years ago. To replace the wood and make the building presentable, it is necessary to replace the rotten wood and repaint the exterior of the entire building.
2) The owner of an old motel is struggling to keep his business profitable. To reduce operating expenses, he has been purchasing used carpet from office buildings to replace carpet damaged by guests. He just purchased 10,000 square feet of carpet which will be used over the next six to 12 months to replace carpet at the motel.
3) The sanitary sewer in an office building extends 150 feet from the edge of the building to the street. A 70 foot portion of the sewer line collapsed and had to be replaced.
Are the above examples of operating expenses or capital expenditures? One of the guidelines offered by the IRS is an operating expense does not extend the life of the asset. Review the general ledger for your expenditures and discuss meaningful expenditures with your income tax preparer. Converting capital expenditures into operating expenses can provide meaningful income tax relief.
Equipment is typically depreciated over a period of years. For example, refrigerators and stoves for an apartment complex would typically be depreciated over five years. Section 179 allows taxpayers to deduct up to $108,000 (2006 limit) for eligible property. Eligible property would typically include personal property and would not include real property. Examples of items deductible under section 179 are machinery, equipment, furniture and fixtures and most storage facilities. Consult with your income tax preparer if you are unsure whether an item can be deducted. The $108,000 limit on expenses is phased out for entities with eligible expenses which exceed $430,000. Each one dollar expense above $430,000 reduces the amount that can be deducted as a section 179 expense by one dollar.
Income taxes can be managed and reduced through counsel with knowledgeable advisors. Maximizing depreciation, operating expenses and section 179 expenses will reduce income taxes.
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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 where cost segregation generates meaningful tax deductions.
City:
- Washington, DC
- Los Angeles, CA
- Miami, FL
- Las Vegas, NV
- Baltimore, MD
- Hartford, CT
- Denver, CO
- Orlando, FL
- Houston, TX
- Atlanta, GA
- Boise, ID
- Little Rock, AR
- Richmond, VA
- Omaha, NE
- Columbia, SC
- Chattanooga, TN
- Harrisburg, PA
- St. Louis, MO
- Palm Bay, FL
- Augusta, GA
- Nashville, TN
- Milwaukee, WI
- Durham, NC
- Albuquerque, NM
- Scranton, PA
- Syracuse, NY
- Youngstown, OH
- Grand Rapids, MI
- Des Moines, IA
- Greenville, SC
Cost segregation produces tax deductions for virtually all property types.
Property Type:
- Tennis club
- Convenience store
- Regional mall
- Office warehouse
- Night club
- Auto service garage
- Apartments
- Mini-warehouse
- Skating rink
- Mobile home park
Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.
Industry:
- Furniture stores
- Publishers
- Food and beverage stores
- Amusement parks
- Truck transportation
- Arts, Entertainment, and Recreation
- Food manufacturing
- Warehousing and storage
- Machinery manufacturing
- Paper manufacturing
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