It Ain't All Big Hair and Cadillacs

Tax Tips for Income Producing Properties

The year is coming to a close and it won’t be long before you begin preparing your 2006 tax return. As an owner of income producing investment property, I wanted to provide to you some food for thought.

As you begin the process of completing your Schedule E, are you and/or your accountant depreciating just the value of your building, or do you bifurcate the value of the land, land improvements and personal property in your building(s)?

If you are simply depreciating the value of your building, you may be losing enormous tax advantages.

IRS tax laws allow owners of residential income producing investment properties to depreciate the value of your building, land improvements (i.e. value of curbs, sidewalks, parking lots etc.) as well as the value of the personal property in the building (i.e. carpet, window treatments, lighting fixtures, appliances etc.). The cost recovery for personal property percentage in year one alone is 20% and can be depreciated over 5 years. The cost recovery percentage for land improvement is 5% in year one and can be depreciated over 15 years. You may even be able to file an amended tax return and perhaps get money back. Your potential refund can be reinvested in additional real estate. Consult a financial professional or call me, I can point you in the right direction.

Some addition thoughts as we close out the year: Do you and/or your accountant calculate the return on your equity in the property(s) you own on a year-to-year basis? If not, you may want to calculate your return in order to best understand whether or not your investment is providing the best return possible. As you begin to lose the tax advantages over time, your money may be better used in purchasing additional investment properties with better returns. You may not even need to sell your current investment. Perhaps borrowing against your equity may be a better solution. Either way, it’s important to understand how your money is working for you.

Please contact me if you are interested in discussing the possibility of selling your property or purchasing additional property.

To reach me directly, call 773 791-2154 or thall@rubloff.com.

Thomas J. Hall
Broker Associate


Depreciation Illustration:


You purchase a building for $600,000 of which the land value is $100,000.

Your net income for the year is $24,800.

For purposes of a simplied illustration, the cost of debt service is not included in the
calculations.


Building:

Recovery Period for Residential Property = 27.5 years
Recovery Percentage for Residential Property for Year 1 = 3.48%

Land Improvements:

Recovery Period for Land Improvements = 15 Years
Recovery Percentage for Land Improvements for Year 1 = 5.00%

Personal Property:

Recovery Period for Personal Property = 5 Years
Recovery Percentage for Personal Property for Year 1 = 20.00%


Without bifurcation:

Purchase Price: $600,000
Building Value: $500,000
Land Value: $100,000

Total Depreciation: $500,000 x 0.0348 = $17,400

Net Income: $24,800 - Depreciation: $17,400

Cash flow before tax = $7,400

With bifurcation:

Purchase Price: $600,000
Building Value: $400,000
Land Value: $100,000
Land Improvement: $50,000
Personal Property: $50,000

Total Depreciation: = $13,920($400,000 x 0.0348) + $2,500($50,000 x .05) + $10,000($50,000 x 0.2) = $26,420

Net Income: $24,800 - Depreciation: $26,420

Cash flow before tax = -$1,620