Cost Segregation Why are 90 of real estate investors overpaying federal income tax
Below is a MRR and PLR article in category Finance -> subcategory Taxes.
Cost Segregation: Why 90% of Real Estate Investors Are Overpaying Taxes
Summary: Learn how business owners can save $50,000 to $100,000 in their first year by optimizing their federal income tax strategy.
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Introduction
Many real estate investors overlook beneficial IRS guidelines for depreciation, leading to overpayments in federal income taxes. These guidelines, although relatively new, offer significant financial benefits by allowing investors to defer taxes. Despite the savings potential?"ranging from $50,000 to over $1 million in the first year?"most accountants haven't integrated these guidelines into practice.
Understanding Cost Segregation
Cost segregation allows investors to convert income taxed at a high rate (ordinary income) into income taxed at a lower rate (capital gains), and it also defers tax payments. This can result in a meaningful reduction of federal taxes.
The Misconception About Depreciation
Many investors mistakenly believe that increasing depreciation merely shifts tax payments to a later date. In reality, it not only defers taxes but also reduces tax rates by converting ordinary income into capital gains.
For example, if an investor sells a property and conducts a cost segregation study, increasing depreciation by $100,000, they can reduce ordinary income taxes by $35,000, while capital gains taxes only increase by $15,000. This results in $20,000 in savings.
Why Isn’t My Accountant Handling This?
Despite trust in accountants, less than 5% of depreciation schedules are correctly established. Some accountants are aware of cost segregation but see it as too costly. Yet, cost segregation is beneficial for properties with an improvement basis of $500,000 or more, and sometimes even for smaller properties.
Your Role as a Property Owner
Many investors leave tax matters entirely to their accountants. However, understanding cost segregation can be simple. If you’re unfamiliar with it, consider whether you pay federal income taxes, own investment real estate, and can use additional depreciation.
If you're actively involved in real estate, cost segregation can provide substantial tax benefits. Passive investors may not benefit as directly unless they are classified as real estate professionals.
Getting Started with Cost Segregation
Start by assessing your eligibility and potential benefits. A cost segregation expert can provide a preliminary analysis at no charge. This will help gauge the feasibility of a study for your property.
Discuss this analysis with your accountant to ensure alignment with your tax strategy. Determining whether to apply extra depreciation in prior years or the current year is crucial. Long-term, incorporating cost segregation into your investment strategy can substantially reduce taxes.
Conclusion
Properly calculating real estate depreciation through cost segregation can significantly lower your tax liability. Despite its current low adoption rate, increased awareness and affordable services will likely make it a standard practice among investors and accountants. By taking proactive steps, you can leverage these benefits for better financial outcomes.
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