Real Estate Accounting
Depreciation deductions can be extremely valuable for a business. For example, in a recent court case, a federal judge ruled a company could begin taking its depreciation deductions for two buildings housing retail stores at a point prior to when they were “open for business.” The ruling allowed the company to show a loss for that tax year, which the company then used to offset income in earlier years and ultimately claim a total tax refund of over $2 million.*
Although this case involved a special 50% depreciation allowance made available by the Gulf Opportunity Zone Act of 2005, the fact remains that even regular depreciation deductions can significantly reduce a company’s tax bill.
If business property has a useful life greater than one year, the owner generally is prohibited from deducting the full cost of the property in the year it is placed in service. Instead, a portion of the cost may be deducted each year as depreciation. The depreciation rules apply to most types of tangible property, with notable exceptions being inventory and unimproved land.
Different schedules specify the proper depreciation calculations for different types of property. The most widely used schedules are set forth under the Modified Accelerated Cost Recovery System (MACRS). MACRS assigns property to a recovery class based on the property’s “class life.”
For example, office equipment is assigned to the seven-year MACRS class. Assume a business purchased a piece of equipment for $20,000 and placed it in service in 2012. The property would be in its fourth year of service in 2015. Applicable IRS tables indicate that the appropriate deduction percentage is 12.49% of the cost, so the business could deduct $2,498 for that equipment in 2015.**
Placed in Service
As the above-mentioned court decision suggests, the date property is placed in service can be an important consideration. Though the IRS has specific definitions for different types of assets, generally, property is first placed in service on the date the taxpayer first places it “in a condition or state of readiness and availability for a specifically defined function.”
Because the definition is broad, taxpayers sometimes litigate how it should be applied to specific situations. In the decision mentioned above, the key issue was the “placed-in-service” date of two buildings that would eventually be used as building supply stores. The IRS had argued that the “placed-in-service” requirement meant that the buildings had to be open for business for retail customers. The court disagreed, however, holding that the buildings were placed in service when they were substantially complete and limited certificates of occupancy had been issued so that workers could enter the buildings to install necessary racks and shelving.
Businesses may be able to benefit from the tax law’s Section 179 provisions to garner faster write-offs for some of their asset purchases. Currently, businesses will be allowed to expense up to $25,000 of qualifying property placed in service during the 2015 tax year, with that limit subject to further reduction once the amount placed in service exceeds $200,000.*** In addition, a current deduction may be available for certain limited amounts paid for property that the business expenses for financial accounting purposes. We can tell you more about these “de minimis safe harbor” regulations.
If you are tired of overpaying taxes, then call 410-466-3779 and ask for Steve Graber. Lower your overall tax liability using depreciation is right up our alley.
Graber and Associates is a Baltimore CPA Accounting Firm with two convenient office locations, Downtown Baltimore and Pikesville. To better service our small business clients who use QuickBooks, we are Certified QuickBooks ProAdvisors.
* Stine, LLC v. USA (DC LA, 1/27/2015)
** Calculation assumes the half-year depreciation convention.
*** Congress kept the Section 179 limit at $500,000 for 2014 in late-year extender legislation.
Cost segregation is the process of identifying your assets and classifying those assets correctly for the purpose of paying federal taxes. In this process, personal assets that are mixed with real property assets are separated out, so all assets can be depreciated properly and potentially increase your bottom line.
Cost Segregation Studies
A cost segregation study is performed to determine which assets can be claimed as personal property instead of real property. These items usually include indirect construction costs, non-structural elements of buildings, and exterior land improvements.
By separating these assets, they can be depreciated over a shorter term which will reduce your current income tax liabilities and increase cash flow. This decreased depreciation period is typically between five and fifteen years instead of the twenty-seven and a half to thirty-nine years for non-residential real property.
For example, items such as carpeting, wall paper, parts of the electrical system, and even sidewalks and landscaping all qualify for the shorter depreciation periods.
Eligibility and Advantages of Cost Segregation
To be eligible for cost segregation, a building must have been purchased, remodeled, or constructed since 1987. This method of tax reduction is best used on new construction, but it can be used retroactively on older buildings as well.
Beyond the benefits of reduced tax liability and increased cash flow, a cost segregation study will provide your business with an audit trail of all costs and asset classifications. This will help put to rest any unwanted inquiry from the IRS in its early stages. Finally, during this process, you may identify possible ways to reduce your real estate tax liabilities as well.
While there are some costs associated with performing a cost segregation study, as long as the assets in question are valued over $200K, it’s worth the time and expense to complete the study and categorize these assets correctly.
If you are tired of overpaying taxes, then call 410-466-3779 and ask for Steven Graber.
Graber & Associates is a Certified Public Accounting firm in Baltimore. We have been operating since 1993 and have offices in Downtown Baltimore – Inner Harbor and Pikesville. Learn more about our real estate accounting services.