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Houston Tax Reduction - a Result of Cost Segregation Houston Tax Reduction - a Result of Cost Segregation
Houston Tax reduction and tax deferral are the primary benefits of obtaining a cost segregation study. Cost segregation is an IRS-guided process for accurately allocating the cost basis of real estate in a depreciation schedule. Income taxes are a substantial burden for most real estate investors. Tax deductions help with this burden. While some level of taxation is necessary, it is both inappropriate and imprudent to pay more than your fair share. Real estate owners and business investors can substantially reduce federal income taxes by expending a modest amount of time in planning and consultation with knowledgeable advisors. Income tax is based on net profit or taxable income. The basic formula for calculating taxable income is revenue less expenses (tax deductions). Expenses can include both direct payments to third parties (labor, rent, supplies, etc.) and non-cash deduction. The primary non-cash deductions are depreciation and amortization. Congress has provided real estate investors the option to claim depreciation as a non-cash expense. The real estate industry has received favorable tax treatment from congress for many years. Tax reduction (tax cuts) are a direct result of increasing tax deductions. The tax deduction benefit real estate owners gain from cost segregation is a higher level of depreciation. This non-cash tax deduction reduces taxable income and income taxes. Real estate depreciation can substantially reduce federal income taxes for real estate investors and small business owners. For example, if the amount of depreciation increased by $100,000 (as result of a cost segregation study), taxable income would decrease by $100,000, and the owner experiences a $35,000 reduction in taxes (based on 35% tax rate). Most real estate owners depreciate real estate based upon splitting the cost basis between land and improvements. The property owner or tax preparer typically estimates the portion for the land and attributes the balance to long-life improvements. Long-life improvements depreciate over 27.5 years for rental residential property and 39 years for commercial property. Long-life improvements are depreciated over 39 years for commercial property, which includes office buildings, retail, warehouse, office warehouse and self storage properties. This methodology sharply understates depreciation that can be lawfully claimed. While this simplistic method is lawful, it cheats the real estate owner of tax deductions. A cost segregation study identifies up to 130 short-life components. Most cost segregation studies identify about 50 to 60 items that are segregated for short-life depreciation. The IRS has provided clear guidelines for identifying items that qualify for short-life depreciation. Engaging a cost segregation preparer who complies with IRS guidelines provides a safe harbor for real estate owners. (Cost segregation is different than component depreciation, which was available until the early 1908s. However, the result of both is to increase depreciation and tax deductions during the early years of ownership.) These short-life components typically comprise 20-50% of the improvement cost basis and are depreciated over 5 years (20.0% per year), 7 years (14.29% per year) and 15 years (6.67% per year). Depreciation effectively changes the character of income from ordinary income to capital gains income. While the maximum income tax rate for ordinary income is 35%, the maximum rate for capital gains is 15% (less than half the ordinary income tax). This affects substantial income tax reduction. Increasing depreciation also affects deferral of payment of income taxes. Instead of paying taxes (at the ordinary income tax rate) in the year income is earned, taxes are paid (at the capital gain rate) in the year the property is sold. Cost segregation effectively generates an interest free loan (until the property is sold) and reduces the tax rate (from 35% to 15%). 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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