Real Estate (Real Estate Tax Reduction)
Real estate investors are burdened with a heavy level of taxation. In addition to federal income taxes, state income taxes, and city income taxes they are also faced with state and local property taxes. Fortunately, federal tax laws are more generous for real estate than for most industries. Real estate investors can shield some of their income from federal income taxes using depreciation. Those who invest in stocks, bonds and gold do not benefit from the use of depreciation. This article reviews real estate depreciation and opportunities to further reduce federal income taxes by increasing the level of real estate depreciation.
Real estate is a physical asset which deteriorates over time. Unlike the castles and manor houses in the United Kingdom and Europe which have lasted hundreds of years, real estate in the United States does not often last more than 50 to 100 years. In an attempt to allow owners to recover the cost of real estate, the federal tax code allows real estate owners to expense a portion of the cost basis of real estate annually. This expense is termed depreciation. And even though real estate typically appreciates in value over a long period of time, real estate investors are allowed to take an annual depreciation deduction.
Real estate is often thought of as land and improvements. Many depreciation schedules are built simply by separating the land and improvements. Land is not depreciable since it does not deteriorate over time. Building structures can be depreciated over 27.5 years for a rental residential property and 39 years for commercial real estate. Many real estate investors use this approach which both defers and reduces the level of federal income taxes.
Depreciation defers the payment of federal income taxes from the time income is earned until the real estate is sold, or a gain on the real estate is recognized. (Real estate owners can use a 1031 exchange to further defer recognition of the gain on real estate.) Depreciation reduces the tax rate for real estate by shifting income which would have been taxed at the ordinary income rate (35%) to either a capital gains rate (15%) or an intermediate rate of (25%).
Real estate investors can increase depreciation and federal tax savings with a process termed cost segregation. Cost segregation is a specialized service typically performed by appraisers and engineers. They identify up to 130 components of the property and quantify the value for each of them. These components can be depreciated over 5, 7 or 15 years. In most cases, cost segregation experts can allocate 20 to 40% of the cost basis (of the improvements) to the short-life items. Through this process, it is typically possible to increase depreciation by 50 to 100% in during the first 5 to 7 years of ownership. In addition, real estate owners can "catch up” depreciation which has been under reported in previous years. This can be done in the first tax return after the cost segregation study performed, without filing any amended tax returns.
Real estate investors benefit from generous federal tax rules which allow the use of depreciation to both defer and reduce federal income taxes. These benefits can be enhanced using cost segregation to increase the level of depreciation.
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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:
- Dallas/Ft. Worth, TX
- Orlando, FL
- Atlanta, GA
- New Orleans, LA
- Memphis, TN
- Houston, TX
- Philadelphia, PA
- Los Angeles, CA
- Miami, FL
- Boston, MA
- Wichita, KS
- Richmond, VA
- Minneapolis-St. Paul, MN
- Harrisburg, PA
- Cleveland, OH
- Indianapolis, IN
- Rochester, NY
- Salt Lake City, UT
- Chattanooga, TN
- Charlotte, NC
- Lancaster, PA
- Jacksonville, TN
- Santa Rosa, CA
- Greenville, SC
- Oklahoma City, OK
- Columbus, OH
- Colorado Springs, CO
- Scranton, PA
- Austin, TX
- Oxnard, CA
Cost segregation produces tax deductions for virtually all property types.
Property Type:
- Shopping center
- Motel
- Strip shopping center
- Lumber storage
- Convenience store
- Hospital
- Medical facility
- Bar
- Commercial building
- Power center
Almost every industry, including the following, can generate cost-efficient tax deductions by using cost segregation.
Industry:
- Textile mills
- Wood product manufacturing
- Air transportation
- Truck transportation
- Arts, Entertainment, and Recreation
- Food manufacturing
- Mineral product manufacturing
- Chemical manufacturing
- Transportation equipment manufacturing
- Amusement parks
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