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Appraisers Lower Costs for Federal Tax Savings on Small Property Depreciation
Tax savings from cost segregation are no longer out of reach for investors in small and medium-sized properties. With the appraiser’s expertise, the fee for the analysis is often one-third to one-half lower than the fees charged by traditional preparers.
A few years ago, a final court case ruled that tangible personal property included in the acquisition or total cost must be depreciated for asset recovery based on the old investment tax credit principles.
This meant that owners of improved properties could differentiate between real and personal property to write off the cost of parts over varying useful lives. Basically, instead of depreciating an entire commercial property over 39 years, or a residential property (single-family rental or multi-family property) over 27.5 years, certain components are correctly identified over a much shorter period of time. About 135 items have a useful life of 5, 7 or 15 years. This is called cost segregation.
The increased depreciation results in lower taxable income (which would have been taxed at 35%) and more capital gains rate (15%) taxed income when the property is sold. It can also be used for any improved property.
Until recently, cost segregation studies were primarily performed by large accounting firms or engineering firms for large and new construction properties, and in some cases the analysis was outsourced.
Prices for analytical reports, which typically ranged from $10,000 to $40,000, were out of reach for small property owners, especially those with less recent equipment. Unfortunately, owners representing the country’s largest segment of real estate investors were mostly ignored by previous cost separation providers.
Now a revolutionary paradigm shift opens the possibility for small property owners to achieve very significant savings. Much of the change is based on introducing the efficiency of highly skilled property appraisers, who often use industry-accepted cost estimation techniques before determining the remaining life of assets. By not “over-engineering” the staffing or production process, professional fees are lower. Still, the results generally match or exceed those of much more expensive reports. This approach has been successfully tested by IRS auditors.
The changes introduced by appraisers in the analysis and reporting of cost segregation relate to: 1) the size of the analyzed property, 2) the age of the property and 3) affordable price. O’Connor & Associates, a national real estate services firm, leverages such techniques to bring about the following beneficial changes:
1. Owners of properties with a $500,000 development fund can benefit from cost segregation. This is comparable to restricted estates valued at $5 million to $10 million or more that previously received.
2. Existing properties built or purchased after 1986 will have significant savings in the first year of cost segregation, even without presenting the original cost documents. The IRS is perfectly fine with recording unallocated depreciation from prior years. This is compared to companies that previously only used the methodology for new construction.
3. The fees are not too high anymore. To analyze and report on many small properties, the prices are low enough to generate at least three times the cost of the report in the first year. This compares to traditional fees of between $10,000 and $20,000 for similar sized properties.
It is wise to keep in touch with the owner’s CPA or tax preparer throughout the process. For older properties, the CPA may need to file a Form 3115 with the tax return to allow the owner to save on previously non-depreciated items – without filing an amended return.
Income-producing properties worth as little as $500,000 can achieve a 3:1 return on tax savings over the modest price of a cost segregation report. If held for 3 or more years, the typical return ratio is 10:1.
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