More tax deductions means tax reductionImportant Commentary for Owners of Real EstateBy Patrick O?Connor, MAIDepreciate Property Improvements Correctly…and Pay Less Federal Income Tax. Most commercial real estate owners are paying excess federal income taxes because they are not depreciating their property as quickly as they should. A cost segregation study allows property owners to both defer and reduce federal income taxes. Cost segregation increases depreciation (a non-cash deduction) for commercial real estate owners. When properly performed by an appraiser with expertise in cost segregation, this is a conservative tax planning tool which reduces federal income taxes by properly allocating the cost basis between land, 5-year, 7-year, 15-year, 27.5-year and 39-year property. (Long-life depreciation is 27.5 years for residential rental properties and 39 years for commercial properties. Carpet and vinyl tile are typical 5-year items. Site improvements such as landscaping and paving are 15-year items.)Depreciation is an important non-cash tax deduction. By increasing tax deductions, commercial property owners affect federal income tax reduction. (Depreciation indirectly reduces income taxes by reducing taxable income. Income tax credits directly reduce income taxes.) The increase in tax write-offs generates such a large tax cut that some wonder if it is a tax shelter or tax evasion scheme. It is not. Cost segregation is an IRS-guided process used to increase tax deductions during the tax preparation process. The IRS has provided a detailed explanation of the items that qualify for short-life depreciation and acceptable methodologies for performing a cost segregation study. Cost segregation studies performed by appraisers in compliance with the IRS’s Audit Techniques Guide are unlikely to be challenged in an audit. Commercial real estate owners seeking tax advice and tax relief can benefit from reviewing the tax relief available from cost segregation.Cost Segregation Study Benefits include Tax Deductions and Tax ReductionBenefits of a cost segregation study are substantial, immediate and enduring. Year 1 federal income tax savings are typically at least two times the cost of a cost segregation study. In many cases they are five to fifty times the cost of the study. The present value of federal income tax savings for a property held for ten years are typically at least ten times the cost of the study. In many cases, the present value of tax savings as much as 30 to 50 times the cost of the report. The cost segregation study is only required once. Its cost is not recurring, but the benefits are recurring during the term of property ownership. A cost segregation study can also materially reduce local property taxes by separating real and personal property for newly constructed properties.Detailed ExamplePreparing a cost segregation study requires only a limited time commitment from the owner, perhaps 10 to 15 minutes. This limited commitment of time results in substantial federal income tax savings, which are both conservative in approach and well documented. Some owners believe their accountant is properly segregating components into the proper classifications. Many accountants and tax lawyers cannot thoroughly research this highly specialized field to understand the myriad number of items which can be segregated and are inadvertently overstating their client?s income tax liability. Furthermore, not obtaining a cost segregation study increases exposure in case of an audit since there is no clear audit trail. A cost segregation study prepared by an appraiser with expertise in land valuation, construction costs and market value clearly documents each of these items. Further, a cost segregation expert can almost certainly sharply increase allowable depreciation.Following is a summary of the results of a cost segregation study based upon a recent assignment: Office BuildingCost Segregation Example

Total costLandDepreciable basis????????

$6,650,000$1,277,500$5,372,500Annual depreciation (using 39-year straight line) $137,756

Accurate Cost Allocation and Depreciation after Cost Segregation Study

Land5-year property7-year property15-year property39-year property
Cost Basis$1,277,500$374,675$9,433$495,189$4,493,203????????
Annual Depreciation$0$74,935$1,348$33,013$115,210

Year 1 depreciation with cost segregation

$224,506

Less annual depreciation without cost segregationAdditional year 1 depreciation
137,75686,750

Year 1 tax savings based upon 35% marginal tax rate

$30,362Who Benefits from a Cost Segregation StudyIf you own real estate and pay federal income taxes or expect to during the ownership period for the property, you will benefit from the results of a cost segregation study. This is true whether the owner of the real estate is a corporation, limited partnership or limited liability corporation. For syndicators, a cost segregation study is appropriate if limited partners will receive material net taxable income during the holding period even if the general partner does not currently pay federal income taxes. The cost segregation study will increase depreciation shield, thereby decreasing and deferring federal income taxes for the investors.Decreasing and Deferring Federal TaxesSince a cost segregation study decreases and defers federal income taxes, let?s review the long-term impact of this deferral. When the property is sold, capital gains tax will be due if the owner does not enter into a 1031 exchange. However, capital gains tax rates are typically 15% for high net worth individuals, while the ordinary income tax rate is 35%. In addition, the deferral during the ownership period has material benefits because of the time value of money. All investors would much rather pay a 15% tax rate when an asset is sold as opposed to paying a 35% tax rate today.When Should You Obtain A Cost Segregation StudyThe best time to obtain a cost segregation study is when you build or purchase a property. Documentation is most readily available for performing a study and a contemporaneous property inspection can be performed to best document results. However, there are options to perform a cost segregation study for property which has been developed or purchased previously.Elements of Preparing a Cost Segregation StudyThe appraiser starts by gathering documents from the property owner and performing a site visit. As necessary, depending on the special-use property found during the site visit, the appraiser would confer with tax counsel and review relevant tax court decisions. For newly constructed properties, most of the information on actual costs can be obtained from construction draws or invoices from contractors. For existing properties, the appraiser performs a quantity take-off for 5-year, 7-year, and 15-year property and estimates replacement cost using recognized sources. The appraiser then values land, 5-year, 7- year, 15-year, 27.5-year and 39-year property based upon inspection, analysis and IRS regulations and court rulings.Does this only apply to large owners?Both large and small owners of income property or owner-occupied commercial property can benefit from a cost segregation study. Commercial properties with a cost basis of at least $200,000 will likely see a material benefit in excess of the cost from a cost segregation study. In fact, owners of single-family rental homes can probably achieve worthwhile benefits by obtaining a cost segregation study.

Qualifications to Consider when ordering a Cost Segregation Report

The ability to value land and real property are critical elements when engaging a tax reduction expert to perform a cost segregation study. In addition, it is essential they have a detailed understanding of rules for classifying 5-year, 7-year, 15-year, 27.5-year and 39-year property. The ability to justifiably increase short-life depreciation materially increases the benefits of a cost segregation study. While most accounting professionals have a rudimentary understanding of the 5-year, 7-year and 15-year property classifications, few have a detailed understanding of this highly specialized niche. Be certain the report provider has scrutinized both the federal income tax code and the meaningful tax court cases to allow you to maximize your depreciation and minimize your federal income tax liability.

While American People can be divided on lots of different issues;there’s one thing most people in this country can agree on.We all hate paying taxes.
Even, our founding fathers hated taxes. That’s why the tax code requires us to pay what we owe but makes it clear that we have the right to take any legal measure available to us to reduce what that amount is and that has been upheld in the highest court in the land.
The key part of this is “legal measures”. However, there are lots of scams out there that if you participate in could land you in jail, even if you didn’t know they were illegal. So it’s important to be able to spot a scam when you see it. It’s also a good idea to have your own tax advisor give whatever idea you’re planning the once-over just to be on the safe side.
The best way to tell if looking at a legitimate tax reducing measure or a scam is to ask yourself, “What does the government get out of this?” You see the IRS, is never going to simply give a tax break that takes money out of their coffers, or reduces the amount coming in, to the benefit of individual taxpayers without some gain being made for the government.
For example, there are all kinds of deductions for real estate, both for homeowners and for investors. Why, because the government benefits, it means they don’t have to provide those homes. There are also many deductions for business. Why, again, because the government benefits from the jobs those businesses provide.
Sometimes the government benefit is a little less obvious and you really have to think about it, for example, the Traditional & Roth IRA, you get to save money that is either tax deferred or tax free. Plus with the Roth you can take the money out without any penalty or income tax after 5 years and you can take your own contributions out any time. Now why is that, what’s the benefit?
If you have money saving up without being taxed, it grows faster and you have more money to retire on, meaning you are less dependent on the government to support you. Plus, in a tax deferred situation, when you start drawing the money out to live on, you then pay income tax on it just like you did when you were working, so the IRS gets tax money coming from you for an extended period of time. Definite benefit, definitely.
The Roth IRA, and my preference if you can qualify, does not require you to pay income tax when you withdraw the money because the tax is not deferred. You paid the taxes when you originally received the money and before you deposited it. So the government still gets the benefit of you being less reliant on them, plus they get their money up front. The reason that you can withdraw it without penalty is to encourage you to take it out and use it.Why, because even though you don’t pay income tax, when you spend it you’ll have to pay sales and other taxes. Again benefit.
Here are some tax reductions techniques I’ve seen, that are definite scams. Social Security Refunds: Get a refund on the money you’ve been forced to pay social security. Just pay the fee and an upfront percentage of the refund to have the claim processed. Not only is there no government benefit here, it would bankrupt an already shaky system.
Slave Reparations: If you are a descent of slaves, you can pay a fee to have a reparations claim prepared for you. Filing this claim just gets you into trouble with the IRS because there’s no authority for it anywhere. While you may or may not consider it just that the US make amends to the descents of slaves through reparations, there is no benefit to the government to make that happen.
Layered Trusts this is a scheme this is promoted based on it being used by the rich and famous. People who are really rich and have held their wealth for generations, hire highly skilled legal and financial advisors to analysis the tax codes and the business and estate laws to shape the best plans for their circumstances. Unless you’re in that position setting up layered trusts to avoid taxes will probably spell disaster for you.
This doesn’t mean you should avoid all trusts. The use of a Living Trust to avoid probate and make it easier to transfer assets and land trusts for both protection and privacy when dealing with your property holdings are both highly recommended and very useful tools for managing your affairs. However, neither of these are tax reduction tools.
Opt Out of Taxpayer Status: There are still books, articles and websites that claim that paying taxes are voluntary because Congress does not have the authority under the Constitution to collect taxes. Meaning paying income taxes is just voluntary. So to stop paying taxes, you can, for a fee, just opt out. Following this method is a definite “Go to jail, Go directly to jail. Do not pass go and do not collect $200″ kind of move.
Avoid Employment Tax Withholding: If you work a regular job and your boss does not collect federal and state withholding & employment taxes, you should either pay them yourself through estimated withholding (like you were self-employed), or find another job. If you are the boss, this is another “Go Directly to Jail” move. You’re messing with one of the benefits the government receives by giving businesses all those tax deductions.
Here what all of these scams have in common, no benefit to the government, either directly or indirectly. If you are being told about a tax shelter or deduction, that provides no benefits to the government, chances are it’s not real. For help with finding out how to get all the legitimate tax deductions you’re entitled to and pay the absolute minimum.