Cost Segregation - Tax Deductions
“Collecting more taxes than is absolutely necessary is legalized robbery.” - Calvin Coolidge, 13th President of the United States
In addition to the numerous tax deductions the Internal Revenue Service (IRS) allows, research indicates that most U.S. taxpayers do not claim all deductions to which they are entitled.
Some of the tax deductions business owners can claim fall under categories such as charitable contributions/donation deductions, medical and dental deductions, moving expense deductions, deducting job costs, travel and entertainment expense deductions, and casualty and theft losses, depreciation and involuntary conversion deductions.
Tax deferral strategies are a great way to minimize taxes, and cost segregation and IRC Section 1031 exchanges are two of the most valuable tax deferral strategies available to commercial real estate owners today.
Phrased as the “almighty tax deduction,” a 1031 exchange provides the investor the opportunity to defer 100 percent of realized capital gains. This equates to an interest-free, no-term loan on taxes due until the property is cashed-out. Most often, the capital gain taxes are deferred indefinitely because investors continue to exchange from one property to the next, and increasing the value of their real estate investments with each exchange.
In these exchanges, business or investment property is disposed of through a qualified intermediary, and the proceeds are used to purchase a replacement property of like kind. This results in a deferral of all or most of the gain that otherwise would be subject to income tax on the disposed property. The replacement property has a carryover tax basis that is generally the value of the replacement property less the gain deferred in the exchange. New guidance from the IRS and some of the most taxpayer-friendly legislation since the Tax Act of 1986 also have made a second form of income tax deferral—cost segregation—increasingly popular.
The primary goal of cost segregation is to identify building components that can be reclassified from real property to personal property. This results in a substantially shorter depreciable tax life and accelerated depreciation methods. Ordinarily, the cost of real, or section 1250, property is recovered over lengthy periods (27.5 and 39 years for residential and nonresidential property, respectively), using the straight-line method of depreciation. Personal, or section 1245, property is recovered over considerably shorter periods (5, 7 or 15 years), and employs accelerated methods of depreciation, such as 200% or 150% declining balance.
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