Archive for June, 2011
Last week, the IRS raised the standard mileage rate to 55.5 cents. If you want to see how this rate has gone up and done, be sure to check out this page put out by the IRS. We topped out at 58.5 cents a mile at the end of 2008 (remember oil prices topped out near $150 around this time) and if you go way back to 1997, the rate was as low as 31.5 cents per mile. It’s been above 50 cents since 2008 and it’s been above 40 cents since 2005.
The IRS announced yesterday that effective July 1, 2011, the standard mileage rate was going up to 55.5 cents. This is up from 51 cents that was set in place at the beginning of the year.
2009 was the last time there were two different rates for a given year. This is also the second highest rate ever with the second half of 2008 still being the highest at 58.5 cents.
Here’s a great story by The Tax Guy about how you can deduct some or even all of the costs incurred in going into some retirement homes. The story talks about the specifics of Continuing Care Retirement Communities and how they qualify for the medical expense deduction. There’s even a great example in the story.
June 15th is right around the corner and with the 15th of the month usually comes some deadlines. First off, if you’re filing a 1040-NR and you weren’t subject to withholding, your tax return is due on June 15. Both corporate and individual second quarter estimates are due so especially if you’re doing something where taxes aren’t being withheld, it’d be a good idea to talk to a tax professional. Finally, foreign corporations that don’t maintain an office or place of business in the United States have to file their 1120-F by June 15.
If you’ve heard those ads on the radio talking about how you can settle with the IRS on your past bills for pennies on the dollar and you had suspicions you had them for a good reason. While there are legitimate companies out there that can help you talk to and negotiate with the IRS, there are also a good share that are just looking to take your money. This is a topic that the Smart Money’s tax blog recently took on. I had a conversation with an IRS agent last month and she confirmed some of the facts in this story, namely that if you have the money, you’re not going to get much of a break.
Inituit’s Small Business Blog had a nice piece on the five common legal mistakes small business make. It’s a short read and important whether you have a business already or are just starting out.
Sometime, common sense prevails. In this interesting WSJ article, Jan Van Dussen took on the IRS and while it wasn’t a total victory, the merits of her case prevailed. She incurred thousands of dollars in personal expenses to take and care for stray cats at her home and when she tried to deduct them, the IRS eventually came and said they were personal in nature. Tax Court disagreed and said that most of the expenses were deductible as “unreimbursed expenses incurred to help a charitable group in its mission.”
The primary reason she didn’t get all of her deductions was because she didn’t get a letter from the charity acknowledging the fact she provided more the $250 to the charity.
One of my favorite places to get tax information is Taxgirl. I mean this as a compliment but she’s not your typical tax attorney. She can take an issue and break it down and write about it in an easy to understand way. It’s a daily read of mine.
Her latest piece is on charitable organizations. Yesterday, the IRS took away the tax exempt status of around 275,000 organizations because they failed to file their returns. She talks about how the rules changed in 2006 for smaller charities and that with three years of missed returns, a lot of organizations find themselves in hot water. She also recommends that you check out the IRS website and in a week or two, Publication 78 because that will show you which organizations lost their status so you can make sure the charities you give to are still considered charitable organizations for tax purposes.
I’ve had a blog since 2003. Over eight years ago I started my Tigers fan site, Tigerblog and since then, my life hasn’t been the same. I’ve been in books, been on the radio and I even had the chance to interview Ernie Harwell. I place it as one of my most important life decisions I’ve ever made. Another good thing is, it’s made me some money. I’ve sold ads throughout the years and it’s forced me to treat it as a business. That’s why I did this interview back in back in 2005 on accounting for bloggers. Once money starts coming in, it’s time to take it a little more seriously.
If you read through the interview (which is focused more on baseball blogs), not a lot has changed since then. One thing you always have to keep in mind is the general rule for a business deduction and that’s that it has to be ordinary and necessary. If you start a movie review blog and you write a review on every single movie you see and you only deduct the price of the ticket for you and not everyone in your family, you’ll probably be in good shape. If you write a review for every fifth movie you see and you try to deduct the price of your ticket, the price of the tickets for everyone in your family and then a family dinner on top of that, you might be in trouble.
Also be cognizant of the hobby loss rules. Eventually you should turn a profit and if you don’t, then your losses may not be allowable. While the hobby loss rules have some general guidelines (this may warrant a post of it’s own), even if you meet the requirements, the IRS could still deem you a hobby under audit so nothing is bullet proof.
Yesterday I gave the ins and outs of cost segregation studies. Today, I’m giving you some of the research resources attached to it. One good place to start, if you don’t mind the investment is CCH’s U.S. Master Depreciation Guide (2011). This guide book will give you the ins and outs of the depreciation rules like nothing else will and it comes with CCH’s top notch explanations.
If you don’t want to spend the money, then I’d recommend Publication 535 which has a section on capitalizing assets in it. I’d also highly recommend the Audit Technique Guide on Cost Segregation. Between those two things, you should have the tools to at least get started.
A while back, I wrote a column for the Oakland County Real Estate Investors Association on cost segregation studies, or the abbreviated cost seg studies. Here’s that column in its entirety.
Get More Money Out of Your Real Estate Investment by using a Cost Segregation Study
“Accounting and tax rules allow me to depreciate my property, which means I am making money but it looks like I am losing money, I am making money because I am legally allowed to pay less in taxes, So this is money coming in because less money is paid out in taxes. It is also known as phantom cash flow.” Robert Kiyosaki, The Real Book of Real Estate
“In recent years, increasing numbers of taxpayers have submitted either original tax returns or claims for refund with depreciation deductions based on cost segregation studies. The underlying incentive for preparing these studies for federal income tax purposes is the significant tax benefits derived from utilizing shorter recovery periods and accelerated depreciation methods for computing depreciation deductions.” Internal Revenue Service Cost Segregation Audit Technique Guide
There are several tax advantages to rental real estate but near the top of the list is the ability to depreciate the purchase price of your investment and utilize that as a tax deduction each and every year. The current rules allow you to depreciate residential rental real estate over 27 ½ years so if you bought a house for $100,000 and do the standard allocation of 80% going to the house and 20% going to the land, you end up with nearly $3,000 in tax deductions each and every year. In a lot of cases, this can turn an investment with a marginally positive cash flow into a tax loss allowing you to escape paying taxes. Even better, it’s not like a typical expense, such as interest expense, where money is coming out of your pocket. As Robert Kiyosaki described in his quote, it’s like phantom cash flow. With that, it can’t get much better then that, can it?
Actually it can. By utilizing what’s commonly referred to as a cost segregation study, you can significantly narrow the window used to depreciate your investment. While you’re robbing the future to pay for the present, in a lot of cases you’re giving yourself tax deductions in the current year that you might be not be able to normally utilize until over 20 years in the future. We all know that a dollar in our pocket now is worth more then a dollar 20 or 30 years from now so let’s take a look at how this is done.
What Is a Cost Segregation Study?
When depreciating both real and personal property, it’s necessary to classify each asset so a useful life has been determined. Computers are depreciated over five years while non-residential real estate is depreciated over 39 years. The shorter the useful life, the better the depreciation deduction is in the early years of the asset. Sometimes, you can’t break down each and every asset (like for a house), so the Internal Revenue Service let’s you use estimates to segregate or allocate costs to various buckets of assets. A house or apartment building consists of a structure, but there’s also wiring, personal property (cabinets and lighting fixtures as an example) and even furniture. This allocation estimate is what a cost segregation study provides for you.
Who Performs Cost Segregation Studies?
There are no requirements to do cost segregation studies but in my experience, the best combination is to have a certified public accountant (CPA) and an engineer work together. This way, you have both the tax side (CPA) and the structural/construction side covered. A CPA could do a cost segregation study by himself but without the proper experience that an engineer could bring to the table, things usually get missed. Of course an engineer could do it by himself, but they usually lack the necessary tax knowledge to fully take advantage of the study. In addition, a cost segregation study that doesn’t utilize an engineer is usually going to be more closely scrutinized by the IRS if there’s an audit because a CPA isn’t a construction expert.
When’s the Best Time to do a Cost Segregation Study?
The best time to do a cost segregation study is when you buy the property. It’s a lot easier to do it on day one when all of the paperwork is fresh and the CPA and engineer can get in there before any work is done on the house. It also establishes all of the useful lives associated with property on day one and doesn’t require any additional paperwork.
What if I bought my a rental property five years ago? Can I still do a cost segregation study?
You can still do a cost segregation study if you have a house that you bought several years ago although the benefit could diminish over time. There is additional paperwork because you have to provide the Internal Revenue Service documentation to show them you’re changing your method of account. This involves filing Form 3115 (Application for Change in Method of Accounting). The good news is, for cost segregation studies, the change in method of accounting is automatic (some changes need IRS approval) and you also get to take advantage of the depreciation benefits entirely in the year that you apply for the accounting method change.
How Much Money Can I Save by Doing a Cost Segregation Study?
The short answer is there will be no savings, at least over the useful life of the asset. If you have a $100,000 depreciable asset, the total depreciation expense will be $100,000 over its useful life. What a cost segregation study can do is give you more of your depreciation deductions now so you have more money to put to use here in years one through five rather in year 20 or year 28.
Here are a few simple examples of what a cost segregation study can accomplish (note: I have spreadsheets that provide more detail on the numbers I’ve provided. These are available upon request by emailing firstname.lastname@example.org).
Example 1 – Assume you buy a rental property for $100,000. A quick and easy calculation has 80% going to the building ($80,000) and 20% going to the land ($20,000). Say you bring in a cost segregation study expert and he’s able to determine that 15% ($15,000) should actually go to the land, 50% ($50,000) should go to the building, 15% ($15,000) should go towards land improvements and then 20% ($20,000) should go towards what’s called distributive trade or service property (these are items like wiring, lighting fixtures and personal property). In the first five years, this would result in an increase of $19,545 in depreciation expense when you use the cost segregation study versus a traditional allocation.
Example 2 – Assume you buy an apartment building for $500,000. A traditional allocation would have 20% ($100,000) going towards land and 80% ($400,000) going towards the buildings. With a cost segregation study, you might get 17% ($85,000) going to land, 56% ($280,000) going towards the building, 10% going towards land improvements ($50,000) and 17% ($85,000) going towards distributive trade or service property. This would give you an increase of $79,128 in depreciation expense when you utilize the cost segregation study.
This sounds great, but how much money am I going to save?
This is where I get to hedge with my favorite answer, “it depends.” If you can use all of the extra depreciation deductions and you’re in a high tax brackets, example 2 could save you in excess of $30,000 in the first five years. On the other hand, if the extra deductions put you in a loss situation and you can’t take advantage of those losses because you fall under the passive activity rules, it might not benefit you at all. As always, you should consult with your personal tax advisor as to whether a cost segregation study is good for you.
This sounds fishy. What is the IRS going to do if you do a cost segregation study?
The IRS not only acknowledges that cost segregation studies are valid, but they also told everyone how they’re going to audit them. If your cost segregation expert knows what he’s doing, he’s read the IRS’ cost segregation study audit technique guide to know exactly what the hot spots are and how to protect the client as much as they possibly can.
Cost segregation studies aren’t for everyone, but if you buy and hold real estate, whenever you buy a property you should at be thinking about doing a cost segregation study. I know some cost segregation study experts will analyze the property to see whether you’ll benefit or not before they even do the work so finding someone who will give you a quick review would limit your risk. Cost segregation studies are just one of the many tools that a real estate investor can keep in their tax planning toolbox.