real estate

How to maximize deductions for business real estate

Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.

Segregate personal property from buildings

Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phaseout if total asset acquisitions for the tax year exceed $2.03 million).

If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.

Carve out improvements from land

As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.

Convert land into a deductible asset

Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.

Another option is to purchase an “estate-for-years,” under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.

More limits and considerations

There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.

© 2017

Depreciation-related breaks offer 2016 tax savings on business real estate

Commercial buildings and improvements generally are depreciated over 39 years, which essentially means you can deduct a portion of the cost every year over the depreciation period. (Land isn’t depreciable.) But enhanced tax breaks that allow deductions to be taken more quickly are available for certain real estate investments:

1. 50% bonus depreciation. This additional first-year depreciation allowance is available for qualified improvement property. The break expired December 31, 2014, but has been extended through 2019. However, it will drop to 40% for 2018 and 30% for 2019. On the plus side, beginning in 2016, the qualified improvement property doesn’t have to be leased.

2. Section 179 expensing. This election to deduct under Sec. 179 (rather than depreciate over a number of years) qualified leasehold-improvement, restaurant and retail-improvement property expired December 31, 2014, but has been made permanent.

Beginning in 2016, the full Sec. 179 expensing limit of $500,000 can be applied to these investments. (Before 2016, only $250,000 of the expensing election limit, which also is available for tangible personal property and certain other assets, could be applied to leasehold-improvement, restaurant and retail-improvement property.)

The expensing limit is subject to a dollar-for-dollar phaseout if your qualified asset purchases for 2016 exceed $2,010,000. In other words, if, say, your qualified asset purchases for the year are $2,110,000, your expensing limit would be reduced by $100,000 (to $400,000).

Both the expensing limit and the purchase limit are now adjusted annually for inflation.

3. Accelerated depreciation. This break allows a shortened recovery period of 15 years for qualified leasehold-improvement, restaurant and retail-improvement property. It expired December 31, 2014, but has been made permanent.

Although these enhanced depreciation-related breaks may offer substantial savings on your 2016 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing deductions that could otherwise be taken later, over a period of years under normal depreciation schedules. In some situations — such as if in the future your business could be in a higher tax bracket or tax rates go up — the normal depreciation deductions could be more valuable.

For more information on these breaks or advice on whether you should take advantage of them, please contact us.

© 2016

Rental Real Estate

by Sherrill Morales, CPA

Tax Supervisor at Atchley & Associates, LLP

Given the current real estate market in Austin, many are considering the benefits of owning rental real estate.

For tax purposes, owning rental real estate can offer advantages and planning opportunities. Taxpayers can depreciate property, deduct interest on borrowed capital, exchange rather than sell properties to defer tax on gains, use installment sales to defer tax on sales, and profit from preferential rates on long-term capital gains. Most importantly, you can generate “positive cash flow”, or monthly income, with depreciation deductions that effectively turn actual income into tax losses.

However, navigating the tax limitations and taking advantage of the exceptions can be tricky. Real estate income and loss is generally considered passive income and loss for tax purposes. Taxpayers cannot use passive activity losses (PALs) to offset ordinary income from employment, self-employment, interest and dividends, or pensions and annuities.

However, you may be able to use one of two important exceptions to this rule:

– The rental real estate loss allowance. As one exception to the PAL rules, taxpayers with adjusted gross incomes of $150,000 or less can claim a rental real estate loss allowance of up to $25,000 for property they actively manage. Active management does not require regular, continuous, or substantial involvement. However, it does require that the taxpayer own at least 10% of the property. Also, to qualify for the exception, married taxpayers must file jointly.

– The election to be treated as a real estate professional. The second exception allows real estate professionals not to treat their rental activity as a passive activity. Therefore, their losses are not limited to passive income. This exception requires material participation by the taxpayer which is demonstrated by meeting one of seven tests. These tests are complex and include the number of hours of participation and the facts and circumstances of the participation in the activity.

If your rental property is a vacation home, the rental income and deductions are determined under one of three sets of rules depending on the number of days you rent the property.

– If you rent your vacation home for fewer than 15 days during the year, no rental income is includible in gross income and no deductions attributable to the rental are allowable.

– If you rent the property for 15 or more days during the tax year and it is also used by you for the greater of (a) more than 14 days or (b) more than 10% of the number of days rented, the rental deductions are limited. Under this limitation, the amount of the rental activity deductions may not exceed the amount by which the gross income derived from such activity exceeds the deductions otherwise allowable for the property, such as interest and taxes.

– If you rent the property for 15 or more days during the tax year but do not use the property for personal purposes for the greater of (a) more than 14 days or (b) more than 10% of the number of days rented, the property may be treated as true “rental” property in which losses are not limited to income.

So, if you are considering renting out real estate that you currently own or might acquire, keep these rules in mind in order to take full advantage of the tax benefits that rental real estate may offer you.