Colorado Real Estate Journal - March 16, 2016
Just because the calendar has flipped to 2016 doesn’t mean that all opportunities to plan and minimize taxes from 2015 are gone. If you or your business bought, sold or held real property in 2015, and you have yet to file your tax returns, there is still time for valuable strategies and planning that could save material dollars when the returns are actually filed and tax is due. The Colorado market has been active, values are up and transactions are plentiful – a perfect storm for planning opportunities, even in hindsight. These strategies and considerations are just a few that might provide value as we work our way through another round of tax returns this filing season. If you bought, or held, property in your business or for investment as a rental (commercial or residential), there is a good chance that cost segregation could maximize deductions that can offset taxable income. The tax code generally requires commercial real estate to be depreciated over a very long life – 39 years for commercial and 27.5 years for residential (single- and multifamily). A cost-segregation study allows the owner of the property (individuals, businesses and investment entities), to “carve out” components of the building that can be depreciated over much shorter periods of time. In addition, if the building was new in 2015, the segregated cost that is placed in the shorter-lived categories could be eligible for “bonus depreciation,” which allows you to write off 50 percent of those costs off the top and the other 50 percent over five, seven or 15 years, depending on the type of property. These deductions are oftentimes overlooked or even discounted as just a “timing issue.” On property with large costs, these deductions can be extremely valuable to owners and developers as a way to raise or retain capital through tax efficiencies. Even if the property was purchased decades in the past, a cost-segregation study is still available. By doing one, an owner can recalculate the cumulative deductions that could have been taken, compared to what they actually took using just the 39 or 27.5 life, and deduct the delta in 2015 by filing a Form 3115 “Change in Accounting Method.” Most CPA firms, as well as reputable specialty tax firms that offer cost-segregation services, will provide estimates of those benefits without charge or commitment. If you own depreciable real estate, whether it was purchased in 2015 or prior, it may be worth exploring what additional deductions you could be taking advantage of. If you purchased or sold depreciable real estate in 2015, allocation of basis is another often-overlooked exercise that can be an effective, and subjective, way to minimize taxes. The tax code generally requires an “equitable” allocation of costs upon the purchase or sale of real estate. If you purchased a building in 2015, for example, likely there will be an allocation of purchase price between land and building. Minimizing the allocation to land, which is non-depreciable for tax purposes, can allow for larger depreciation on the building and its components. A larger, and proper, allocation to the building in turn drives more depreciation deductions on the return. These allocations are subjective and may be different based on a buyer’s determination of reasonable value between the two. Selling depreciable real estate may also require an allocation between those components, which may result in more, or less, tax based on the approach used. In contrast to buying an active business where the buyer and seller generally and contractually agree, and disclose the consistency on their tax returns, on the purchase price allocations including the business goodwill and intangibles, with most real estate transactions, there is only a single settlement or closing statement that agrees on the total price of the property. A buyer and seller may have different allocations with regard to land, building, personal property, etc., and they can both be correct even though they differ. If you are a land developer who subdivided a parcel of property and sold lots during the year, consideration would also need to be given to how to allocate land costs to the developed lots. This may be based on acreage, relative values of the completed lots, frontage foot, etc. Again, a reasonable and equitable allocation should be made, which opens the door to subjectivity and opportunity within that range. Elections also can be made to accelerate common-area costs that are able to be estimated and yet to be completed on the project as well. Especially if you are a dealer, i.e., subject to ordinary income rates on the sale of lots, minimizing taxes on sales now will enable more capital to be available for the project as a finance mechanism. If you have not yet started physical construction or development on the property, or otherwise crossed the line into “dealer” territory, prospective strategies may exist to take advantage of capital gains inherent in the property. Nearly every type of real estate transaction provides opportunity when it comes to income taxes. Effective tax planning can be a major driver of value to your real estate investment. Failure to engage a real estate-specialized team of tax professionals (CPAs or attorneys) based on cost of services, not knowing better or whatever the scenario can lead to missed opportunities, lower after-tax returns and, ultimately, less money to invest in the next project.