When it comes to tax planning, the key IS planning. Strategy first, then implementation and round it all off with proper reporting. Through my blogs, books, webinars and home study courses, I talk about “WHAT.” But that’s often not enough to successfully figure out the “HOW TO” for your personal situation.
I met with a new client, a Doctor, and discovered exactly how expensive the lack of a strategy could be.
The Dr had a lot of real estate and had been planning his exit from his medical practice so that he could devote his time full-time to real estate. One thing he had done, after listening to my talks, was get a cost segregation study done. This study will evaluate the various parts of your real estate purchase. For example, when you buy a house to rent out, part of the purchase price can be allocated to land and part of the price allocated to a building. In fact, that’s the traditional way that tax preparers will use to prepare your depreciation schedule on rental properties. The next step is to consider what part of the property was actually personal property.
Personal property includes flooring, light fixtures, HVAC, garbage disposal and even the paving on the driveway. Personal property is depreciated over a much shorter time so that there is more depreciation at the beginning. By preparing a cost segregation study to allocate real property, personal property and land, you can front end load the depreciation.
More depreciation means more expense and that means a big tax loss.
The Dr told me that he had heard me talk about cost segregation studies and front-end loaded depreciation. He paid extra for his CPA to learn how to recreate that plan. And now, a year later, he was ready to retire and devote his life full-time to real estate.
The problem with his real estate tax strategy is that he implemented a year too early. By front-end loading his depreciation, he created large losses. Plus, he had learned from me how he could do ‘catch-up’ depreciation. His old accountant learned how to do that too, but didn’t follow through on learning how to implement it. The end result was that the Dr had a big loss, but he also had a high earned income. He couldn’t take advantage of any of the loss. So, it was suspended until he sold the property or had a big income to offset it.
Now, he was a real estate professional. It would have been the time to front-end load the depreciation and then file with catch-up depreciation. It would have been all taken against the final bit of other income he had. Instead the catch-up depreciation was used up and suspended for the future.
One more year and he would have had a much different outcome.
Want to learn more about real estate strategies that can put more money in your pocket? Maybe it’s time you had a Real Estate Accountant in a Box.