Cost Segregation - Tax Deductions (Tax Rule No.1: Don’t cheat the IRS)

Tax Rule No.1: Don't cheat the IRS. But that doesn't mean you should cheat yourself. Take every legal tax deduction you can.

In addition to the numerous tax deductions the Internal Revenue Service 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.

Owners of investment real estate can take advantage of a depreciation technique called cost segregation that could save them hundreds of thousands of dollars in federal income tax this year. It does so by increasing their depreciation and reducing their income tax rate from 35 percent to as little as 15 percent. It can also help defer payment of much of the tax until a building is sold.

Typically, the increased depreciation in early years of ownership can offset much of the income derived from the property. When depreciation advantages expire, the property can be sold, and taxes are paid at the capital gains rate of 15 percent. In such cases, this defers income taxes by five, 10 or even 15-plus years.

Cost segregation involves separating up to 135 components of real estate that depreciate faster than the building itself. Most investors fail to identify all of them. A real estate appraiser can accurately value and document those five-, seven- and 15-year items. Such items typically represent 20% to 40% of the total cost. Properly depreciating each can increase depreciation by 50% to 75% during the early years of ownership.

Cost segregation simply helps the property owner achieve accurate and timely depreciation instead of deferring much of it for 39 years (for commercial property) or 27.5 years (for apartments). Imagine waiting thirty-nine years to depreciate carpet that wore out after five! Incredibly, that is what most owners do. Don't cheat yourself, take all lawful deductions.

O'Connor & Associates is a national provider of commercial real estate consulting services including federal Tax Reduction , cost segregation, due diligence, renovation upgrading cost analyses, tax return review and apartment inspections.