Tax deferral is the main benefit of cs; However, a popular misconception about cs is that it is only used for tax deferral, not tax deduction. The issue of tax deferral and tax deductions is misunderstood by both sophisticated real estate investors and tax professionals. The consequences of this misinformation are unfortunate because many real estate investors ignore tax cuts, which would lead to material income tax deductions and tax deferrals.
This results in an income tax deferral and an income tax deduction. The income tax deferral is effective because more depreciation is taken in the early years of real estate ownership. An income tax reduction is obtained because more income is taxed at the capital gains rate (maximum 15% versus the usual income tax rate of 35%). Tax deferral delays tax payments until a future date.
The mechanism for calculating tax deferrals and tax deductions is straightforward but not intuitive. Many accounting professionals believe that the only advantage is deferral of taxes until they consider a mechanism or recognize a sales gain. Tax deferral is not the only benefit that must be realized.
The following example illustrates the mechanism for recognizing sales gains and withholding taxes and the tax-deductible benefits derived from a cost-separation study.
John bought an apartment building five years ago. Cumulative depreciation over ownership is $600,000 based on the results of a cost-separation study. Cumulative depreciation would be $400,000 without a cost segregation study.
The cost split study identified five-, seven-, and 15-year properties in addition to 39-year properties and land. Tax expert John discusses the condition of the property five, seven, and 15 years at the time of sale. They agree that the value of short-lived properties (five, seven, and 15 years) equals their basic depreciation expense. Therefore, the tax rate for the additional $200,000 of depreciation is the capital gains rate.
During each year of ownership, John receives an additional $40,000 in depreciation as a result of the cost splitting study. This additional depreciation reduces his federal income taxes by $14,000 per year ($40,000 X 35%) and by $70,000 over five years. After selling the property, the capital gains tax increases by $30,000 ($200,000 X 15%). The net tax savings are $40,000 ($70,000 — $30,000).
Separation of expenses provides both a tax deduction and a tax deferral.
Splitting costs results in tax deductions and reduces federal income taxes across the country and in every market size. Below are just a few examples where splitting costs results in a meaningful tax deduction.
City:
Orlando, Florida
New York, NY
Houston, Texas
San Francisco, CA
Los Angeles, CA
Boston, MA
Atlanta, GA
New Orleans, LA
Miami, Florida
Bridgeport, CT
Portland, OR
Stockton, CA
Santa Rosa, CA
Little Rock, AR
Charlotte, NC
Palm Bay, Florida
Austin, Texas
Boise, ID
Durham, NC
Providence, RI
Baton Rouge, LA
Detroit, MI
Wichita, KS
Omaha, NE
San Jose, CA
Oxnard, CA
Greenville, SC
Lancaster, PA
Poughkeepsie, NY
Nashville, TN
Splitting costs results in tax deductions for almost any type of property.
Property type:
Warehouse
Apartment
Motel
Discount shop
village club
Strip shopping center
Used car lot
Department store
Truck stop
Self storage
Almost every industry, including the following, can generate cost-effective tax deductions by using cost splits.
Industry:
Warehousing and storage
Good wholesale that doesn’t last long
Electronics and equipment stores
Fabricated metal products
Electrical component manufacturing
Textile product factory
Printing activity
Truck transportation
Automotive parts distributor
Chemical Manufacturing