Tax Reduction Strategies
Tax reduction strategies should be part of your purposeful investing plan. Are you capitalizing on pre-tax planning? Investing in real estate (or any investments for that matter) is all about strategy. While everyone has different objectives and motivations for investing, for most the end game is about making the most amount of money. I believe however if you were to really ask and probe you would identify that your real objective is about KEEPING the most amount of money.
Pre tax planning: I am stunned to hear how many people do not do this. Pre tax planning, usually done about this time of year (Nov) is paramount to strategically minimizing your tax liabilities. Taxes may quite possibly be the single largest expense we have so taking the time to minimize (legally) this liability is a vehicle that must be utilized.
When you are having a great year from an income standpoint there are a number of things that may help to reduce your tax liability. At 11:59 p.m. on Dec 31st while you are celebrating the New Year coming in something else is happening quietly in the back ground. Your tax liability is set in stone; the time to limit that tax liability is in advance of that time. Strategizing with your tax preparer can give you a pretty close picture as to what your tax liability will be for the year. If you are not happy with the assessment of what he or she says you may owe, they can give you insights as to how to avoid such a high number.
Some tax reduction strategies: You are told you may owe $20,000 in taxes so your strategy could be to make another investment and write off all the expenses in the acquisition of the investment. Or do some improvements to one of your properties or buy some tools related to your trade or perhaps some office equipment or appliances. Anything you spend money on that will be a tax deduction will reduce this tax liability. I trust you would rather spend money on purchasing something you can use or something that may help to increase your revenue as opposed to giving it to Uncle Sam.
Another of the tax reduction strategies is segmented depreciation: This strategy is used by many when they want to accelerate their depreciation on a property to reduce their tax liability. How it works is fairly simple.
A typical investment property is depreciated over 27.5 years. Or 3.63 percent per year. Now this depreciation does not work for the full value of the property as the land is never assumed to depreciate in value. So the building itself is depreciated over 27.5 years or 3.63 percent per year. So if you have a property that you bought for $100,000 and the market you bought it in has (let’s say) a 10% land to building value ration you would have a building worth $90,000. The depreciation benefit would be $90,000 times the 3.63% depreciation benefit or a $3,267 tax deduction. This is where most people stop, but the segmentation process lets you take it further.
Introducing segmented deprecation: Here you apply a value to each segment. The land (no depreciable benefit) The building 27.5 Years deprecation or 3.63% per year. The personal property 5 year deprecation or 20% per year Land improvements 15 years deprecation or 6.66%
So you will have to establish value for each segment for this example lets say the land has a 10% of total purchase price as its value, 10% to land improvements and 10% for personal property which leaves the building value at 70%.
The Building: So if you have a building that has a value of $70,000. The depreciation benefit would be $70,000 times the 3.63% depreciation benefit or a tax deduction of $2,541
Personal property: (things like A.C. and furnaces, carpeting and appliances) these items are said to depreciate much quicker so the deprecation on these is said to be 5 Years or 20% of the value of the personal property. $10,000 time 20% = $5,000.
Land improvements: (things like shrubbery, fences and driveways) these items are depreciated over 15 years or 6.66%. So if you had 10% of the $100,000 investment as land improvement the $10,000 in land improvements would look like this. $10,000 times 6.66% + $666 So adding up your building depreciation along with personal property and the land improvements we have: Building $2,541 in tax deductions Personal property $5,000 in tax deductions Land improvements $666 in tax deductions Total $8207 in tax deductions
So you see segmentation can increase significantly your tax deductions in this example the deductions went from a $3,267 in tax deduction and increased about 2.5 times to $8,207 in tax deductions.
Purposeful investing is all about implementing tax reduction strategies, if this is interesting to you talk to your tax preparer. There are pros and cons to both methods so strategizing what is best for your objective is an important aspect of investing strategies.