There is little doubt among CPAs that the Obama Administration will fulfill its campaign promise to raise income taxes for small businesses and upper middle income individuals (above the $250,000 annual income level). Most real estate investors hold their properties as partnerships and limited liability companies which are pass-through entities, and thus are taxed at individual rates. Moreover, excessive deficits incurred by the federal, state and city governments provide ample predicate for increases in taxes across the board. New York State has already raised the individual tax rate to 9.25% effective in the fourth quarter of 2009.
Strategies to Consider:
A. Cost Segregation- the IRS Code allows a taxpayer to depreciate a an improvement” to a real estate asset and take an immediate write-off up to $250,000 dollars per year against profits. For example: if a group of doctors decide to purchase a property to run their medical practice and they install a chairlift, the cost of the chairlift would be considered a non-permanent nor fixed improvement and thus qualify for the write-off. This tax strategy is vital to every real estate investor to keep in mind when considering a property purchase, renovations to the property and the costs of the improvements. Dependent on what these improvements are you might be able to deduct the costs and obtain a rebate from the federal government.
B. Sound RecordKeeping-Although one might take this concept for granted, this year due to the awakened appetite of our government for revenues, an increase in audits is anticipated. Therefore, allocation of expenses between direct and indirect expenses is crucial. Examples of direct expenses are: rent, insurance, utilities, and telephone. Indirect expenses are less apparent such as travel, office supplies and professional fees. Additionally, owner-operators especially need to pay attention to recording all your expenses, whether they are made in cash, credit card or debit card and to retain all receipts for backup.
C. Depreciation-Even if cost segregation would not be applicable, many necessities of running a real estate investment business can be depreciated at different terms. Namely, depending on the improvements to the property, you might be able to depreciate the asset for a shorter term than a fixed-permanent asset which has the 39 years term for commercial real estate depreciation. This strategy similar to cost segregation would benefit you with a deduction against your profits or a loss to write down.
D. 1031 Exchange-When purchasing/acquiring a property by more than a single investor, partners should consider whether it would be worthwhile to incorporate more than one legal entity to hold the property. Down the road, one or more of the partners may want to exit the partnership. Holding the property in more than one legal entity provides all partners with added flexibility should that eventuality occur in the future and would facilitate the division and distribution of the ownership shares between the exiting partners. This in turn would afford the partners who exit the ability to do a 1031 exchange and carry-over the capital gains by investing in another property within 180 days as prescribed by the IRS code.
E. Finally, real estate investors should be aware that in 2010 there is a one-year moratorium on the estate tax exemption. This means that a trust or family limited partnership can leave an unlimited amount to heirs without concern that any amount of the bequest will be subject to the estate tax. That being said, given the federal government’s need for revenues, investors should keep alert to any changes in the law that might revise the current stay on estate taxes, and make it retroactive and applicable. In NYS the estate tax continues to limit the bequest exemption to $1 million dollars-any bequests in excess of $1 million dollars will be subject to the NYS estate tax.
Caution: With all 5 of the above tax strategies, it is imperative that you consult with a qualified and licensed CPA to determined whether and to what extent you and your properties can benefit. Please feel free to contact our Panel Expert, Joseph Gil, should you have any questions about your 2010 taxes.
Interview with Panel Expert: Joseph Gil, CPA.
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