New IRS Regs Target Real Estate Investors

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FYI, I have no connection with the author of this and no knowledge of this subject.  Just on their mailing list and thought I would pass this along.


The headline says "real estate investors" but the truth is that these new IRS rules became effective onJanuary 1st for anyone who has property they might need to repair at some point.

The news isn't good.

These rules have just made it a lot harder to take a repair deduction if you fix something on your investment property. If you don't get the repair deduction, you have to capitalize the expense as an asset and then depreciate it over time. That means you might spend $10,000 to repair something, only to find out you can only take a deduction for a few hundred dollars.

If you're watching your cash flow, this could be very expensive for your business or real estate.

In today's USTaxAid alert, I'm going to go briefly over the new rules. For more information stay tuned to the blogs at USTaxAid. I'll go over the new rules in more detail this next week and give you some strategies to help you get ahead of a potential problem. There could actually be a silver lining to all of this.

Let's look first at how it used to work if you had a building for rent or for your business. The building was considered one structural component. If you made a repair that seemed significant by itself, it wasn't when you took into account the entire property. There is often a fine line between improving a property and increasing its value versus repairing to keep something essentially the same. The improvement should be capitalized. The repair is a deduction. When you're comparing the expense against the entire cost of the building, the expense is less significant.

The IRS now dictates 8 different separate components of the property. An improvement/repair is determined based on the overall value of the specific component.

There are more rules, in fact over 100 pages of them, but let's stop right here. That's because this is a HUGE win if you have property. For years, we've talked about cost segregation studies and we were very specific in what we called them. That's because the IRS shut down something called component accounting for buildings years before. There had been a lot of misuse of the tax break and so the IRS reacted strongly and shut it down. But the general principal of breaking down the different segments of your real estate. So the cost segregation study was born.

Now the IRS's new regulation requires you to divide up your property along the lines of a cost segregation study. That means you'll be able to front-end load your depreciation, if you want, to create more of a tax loss. Of course, this only works if you're able to take advantage of the loss against other income. This is important because not only does it take away the past potential issue with component segregation, but it is actually required to break down your property with something like a cost segregation study.

Like I said, there are a lot more rules to watch if you have real estate, whether for investment or in your business. There are big tax advantages, but only if you've set up your overall tax strategy to take advantage of them.

I'm taking the next two months to expand the existing Real Estate Accountant in a Box home study program. There are additional strategies, implementation tips and reporting guidelines, all designed to provide a legal way to reduce your taxes, and still sleep at night.


Diane Kennedy
CPA, Tax Strategist

P.S. Please check back at this next week. I'll have more details on the new IRS repair and capitalizations rule

Thanks Diane, Your post is almost is over my head even though I do my own REI taxes and at least have an interest in the facts here.

>>That means you'll be able to front-end load your depreciation

Can you give an example or shed a bit more light on this? I have 14 rentals and this sounds like something important for me.

@Curt Smith , you'll need to send an email directly to Diane to get a response. Or perhaps leave her a comment over on her blog at Eric just was sharing one of her excellent tax articles. That said, what she means by "front-loading depreciation" is the fact that the IRS now allows you to break down the property acquisition costs into more categories with shorter depreciable lives. This would create a higher depreciation expense in the early years than if all the costs were in just a few of the longer-life categories. It also means that those items will fully depreciate in those early years and the yearly depreciation expense will decrease over time.

My Atlanta based CPA is giving a seminar related to this new legislation.   I posted about it in the Marketplace a week or two ago.   If you want the info, shoot me an email...I have it on my laptop at home...

"If you're watching your cash flow, this could be very expensive for your business or real estate."

I am confused by this statement. I don't understand how the tax treatment has any bearing on my current cash flow. If I have to spend $10K to repair or replace something, my cash flow is already affected regardless of the tax treatment.

I understand that capital improvements are depreciated and the cost is recovered over time; whereas, a repair expense can be taken in full but the tax savings is at best 25% of the repair expense, but more than likely just adds to suspended loss carryforward. Either way, I am out of pocket $10K for the project cost. It is expensive for my real estate rental activity regardless of the tax treatment. We mitigate the risk of a large expense by having a reserve fund, by having multiple income producing properties, by carrying adequate insurance, and by staying on top of maintenance issues while they are small and inexpensive. These business practices mitigate risk, not tax treatment.

On the other hand, if I did not have the expense at all, then my rental income is still taxable and not offset by either a repair or depreciation expense. My taxes are always less than the income I make, so what does Diane mean here?

Is this statement just an exaggeration to create a sense of urgent need for her services, or, is there really some substance behind the comment that I am not seeing.

If someone understands what Diane is trying to say here, would you please explain it to me.

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