Tax Time… Tips to save money and new regulations that may help
One of the key advantages to owning real estate as part of your investment portfolio is that it offers tax advantages that may result in paying lower taxes than other investments. The main goal of financial investment is to earn profits. However, from a tax perspective, the goal is to show as small a gain as possible, so that the least amount of taxes are owed. With proper planning, real estate investment can meet both of these goals.
There are many expenses that can be deducted from real estate investment income to reduce the taxable income. Common expenses include repairs, maintenance, real property taxes, insurance, management fees, automobile expenses, interest expenses, and depreciation. Some of these expenses are fixed, such as insurance, but other expenses can be increased in order to lower the net gain. For example, interest expense can be increased by borrowing a larger amount of money. The owner can then deduct the cost of the interest payment while increasing his return on equity. Another expense that can vary depending on how assets are classified is depreciation. Depreciation is a deduction that assumes the building, or an improvement to it, will lose value over time and allows the owner to deduct part of the value of the asset each year. This does not affect cash flow, but it does help lower taxes. The downside to depreciation is that it may take many years to recoup the cost of the improvement.
New tax regulations collectively referred to as “repair regulation” allow an owner to expense certain improvements, expenses, or repairs, that previously needed to be depreciated. This may result in large tax savings for a given year. It helps to understand the potential cost savings by looking at the following example. If a capital improvement of $1,000 is done to a commercial building (for example new electrical wiring), and is depreciated over 39 years, the owner could only deduct 1/39th of the cost each year which is about a $25 deduction. If the owner is in the 30% tax bracket, this deduction would save him $8 per year. On the other hand, if the whole $1,000 can be expensed in the year it is paid, the owner would save $300 in taxes that year.
An example of one of the new tax regulations is the De Minimis Safe Harbor Election. This allows a company to treat all costs under a certain dollar amount as an expense, even if it would have been considered a capital improvement (that needed to be depreciated) in the past. For companies without audited financial statements this amount can be up to $500 per invoice or item. For larger companies with audited financial statements and a written policy, the expense amount can go up to $5,000. Another example is the Small Taxpayer Safe Harbor Exception – If your company meets certain threshold requirements, it can make an election to expense up to $10,000 or 2% of the unadjusted cost basis of the property (up to a certain amount) of capital improvements instead of depreciating them. Using either of these repair regulations will help lower your tax bill in the current year, by reducing the amount that needs to be depreciated over multiple years.
If you believe you may be able to benefit from these new rules, talk to your accountant. By having the right team of professionals including a commercial realtor, certified public accountant and real estate attorney working for you, you will find real estate investment profitable and benefit from paying the least amount of taxes.
-Dan Stiebel, CCIM