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Income Taxes (How Catch up Depreciation Can Save Real Estate Investors over $1 Million in Taxes) Income Taxes (How Catch up Depreciation Can Save Real Estate Investors over $1 Million in Taxes) Income taxes are a substantial burden. Reducing income taxes provides real estate investors a higher level of return and additional capital for real estate investment. Income tax laws are amazingly complicated. Most income tax preparers will readily agree they have a breath of knowledge but the depth of knowledge in many areas is limited. Many income tax preparers are aware of a concept known as cost segregation to increase real estate depreciation. However, few are aware you can catch-up depreciation underreported in prior years. This article discusses how to generate substantial amounts of depreciation without filing amended income tax returns. Cost segregation reduces federal income taxes by both reducing and deferring the payment of taxes. It reduces the amount of federal income taxes by revising the character of income from ordinary income (maximum tax rate 35%) to capital gains income (maximum tax rate of 15%). It defers payment of income taxes from the year when income is earned until the property is sold, or the gain is recognized. Cost segregation's ability to reduce your income tax rate by increasing the level of depreciation is not intuitive. Many income tax preparers initially believe that increasing the level of depreciation simply defers payment of income taxes. Cost segregation increases depreciation by classifying a portion of the cost basis as short-life property. Short-life property includes items such as carpeting, vinyl tile, paving and some signs. When the property is sold, the market value of the short-life items is typically similar to their depreciated value. The short-life items deteriorate over time. Since the market value and remaining cost basis of the items is similar, there is no gain on sale. Hence, the depreciation taken is not recaptured on sale. Instead, a portion of the gain which is equivalent to the additional depreciation taken for short-life items, is taxed as capital gains income. Since the capital gains tax rate is less than half the ordinary income tax rate ( at the maximum level), cost segregation materially reduces the income tax rate. Obtaining a cost segregation study typically increases depreciation in the first five to seven years of ownership by 50 to 100%. For property purchased on or after January 1, 1987, it is possible to "catch up" depreciation which has been underreported since the asset was placed in-service (without filing amended income tax returns). Instead of filing amended income tax returns, the taxpayer files a form 3115 (change in accounting method). This form is filed with the first income tax return after the cost segregation study is performed. For example, assume an office building has been owned for 15 years. A substantial amount of depreciation can be utilized when the first income tax return is filed. All the 5, 7 and 15 your property (probably 20 to 40% of the cost basis), can be depreciated on the first income tax return. In some cases, this has allowed taxpayers to not pay any federal income taxes for several years. Federal income tax laws are inappropriately complicated. Special tax advantages for real estate investors are a portion of what makes federal income tax laws complicated. However, a knowledgeable advisor can guide you through the process of obtaining a cost segregation study and using and filing a form 3115 to catch-up depreciation underreported in prior years. Click here for a FREE preliminary analysis of tax savings resulting from 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 where cost segregation generates meaningful tax deductions. City:
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