Apartment owners can face staggering expenses to maintain apartment
communities. The upkeep of even a modest community could involve
groundskeeping, unit renovation, and replacements, such as parking lot
asphalt and fencing. Another steep expense is federal income tax - and
in some areas an additional state tax on income - but through an
innovative study known as cost segregation, the depreciation of
property components can be used to help lower federal taxes.
Today,
more apartment investors, especially those whose occupancy rates are
challenged by the nation's single-family housing, are taking a close
look at every possible avenue to lower costs. That's a frustrating task
in the apartment business. One historically underused technique for
saving money, in this case saving taxes, is to ensure that all
depreciable items are reflected accurately on tax returns.
Those
items are not limited to copiers, automobiles and heavy equipment. The
list extends to a wide range of buildings and improvements. In fact,
the IRS recognizes 130 items that depreciate over much shorter time
periods than the standard depreciation of 27.5 years for an apartment
community. Many of those items, such as parking surfaces, landscaping
and even certain wall coverings, are present in large proportions on
typical apartment communities.
A cost segregation analysis, when
reflected on deprecation schedules, reduces taxable income now and also
defers taxes on capital gain amounts until the community is sold. At
that time, the recapture of taxes on the extra depreciation taken can
occur at a much lower rate than the 35 percent max tax rate that was
avoided with the extra losses.
Don't forget the time value of
money by deferring that inevitable tax by a few years. In light of the
130 IRS-identified "short life" items, this conservative tax-planning
tool can help apartment owners allocate more costs to five-year,
seven-year, 15-year and 27.5-year improvements versus the land value on
apartment communities.
Apartment communities, according to IRS
rules, depreciate over the course of 27.5 years. This is 10 years less
than the depreciation estimated for office, retail and industrial
properties, which equal quicker savings for apartment community owners.
Items that are found in every apartment, such as carpet, linoleum,
window treatments and appliances, are categorized as five-year items,
meaning that they are typically replaced after five years of use.
Wide Range of Applications
Whether the community was recently purchased, has been owned for a
while or is on the market to be sold, a cost segregation analysis can
help at any stage of ownership by reducing federal income taxes and
showing future depreciation. The optimum time to do this is preferably
as soon as ownership is taken, whether the property was bought or
built. Any commercial property built after Dec. 31, 1986, is eligible,
and there are "catch-up provisions" to accommodate higher savings in
the first year when a cost segregation study is completed for
communities that have been owned for several years.
Communities
of all sizes can benefit, from small communities of fewer than 10
apartments to communities that span several city blocks. If the
property has an assessed value of at least $200,000, the cost
segregation evaluation can almost always produce substantial federal
income tax savings.
Preparing for a Study
A small amount of
an owner's time is required when working with a consulting firm that
specializes in cost segregation. And it is advisable for the owner's
CPA or tax accountant to collaborate with the consultant, ensuring the
most advantageous application for that owner's particular financial
circumstances.
The
original purchase price of the apartment community is the cost basis,
so owners receive savings on their initial investment, as well as on
improvements. With research that is both quantitative (square footage
of asphalt, pavement, ect., or quantities of wall or window coverings,
ect.) and qualitative (judgment of remaining life) a specialized
analysis and calculation is conducted before a report is issued. This
report becomes the backup documentation for federal income tax returns.
Patrick
O'Connor, MAI, is president of O'Connor & Associates. The firm, in
business since 1974, specializes in state and federal tax reduction
services, real estate appraisals and research and consulting
nationwide. With offices in Houston, Dallas, Los Angeles and Newport
Beach, the firm employs more than 130 people. Patrick O'Connor is
frequently acknowledged by national publications as a respected source
of information on real estate trends.
http://www.cutmyfederaltaxes.com
