INCREASING THE DEPRECIATION DEDUCTION
Maximize the deduction for depreciation on apartment buildings :
1. To increase the depreciable basis of the multi family asset, take the higher of either the tax role or an independent appraisers evaluation.
2. To decrease the length of time the asset is depreciated, identify personal property assets. They can be depreciated over shorter lives.
Various methods of depreciation are used for different classifications of personal property. Real estate investments with lives of three, five, seven, and ten years may be depreciated by the 200 percent declining balance method. The greater the depreciation, the higher the expense deduction, and the more the Internal Revenue Service (IRS) helps to pay for your investment.
Converting Real Property into Personal Property
The IRS defines tangible personal property as any personal property except land and improvements thereto, such as buildings or other inherently permanent structures (including items that are structural components of such buildings or structures) (Reg. 1.48-1[c]). The courts have concluded that “permanency” is the most pertinent test in the determination of whether an asset is a structural component and not personal property. They have applied six tests to assist:
1. Is the property capable of being moved and has it in fact been moved?
2. Is the property designed or constructed to remain permanently in place?
3. Are there circumstances that tend to show the expected or in-tended length of affixation?
4. How substantial a job is the removal of the property and how time- consuming is it?
5. How much damage will the property sustain upon removal?
6. How is the property affixed to the land?
Personal Property Items Found in Apartment Buildings
The following represent assets found in apartment complexes that normally qualify as personal property according to Calstate companies and the IRS:
• Furniture such as beds, tables, chairs, lamps, and sofas
• Carpets, drapes, blinds
• Security and decorative lighting
• Refrigerators, garbage disposals, washers and dryers
• Pool equipment and furnishings including pumps and filtering apparatus
• Recreational equipment pool table, weights, and exercise equipment
Typically, personal property amounts to less than 3 percent of the building’s component costs. The remainder of the apartment is assigned a depreciable life of 27.5 years. The trick is to hire a cost segregation analyst, who maximizes the benefits by identifying, classifying, and segregating more than 3 percent of the building’s assets for an accelerated depreciation for federal income tax purposes. This may mean 3 to 20 times more savings than the 3 percent found in identifying personal property. Power outlets in the office, decorative paneling in your reception area and conference room, oversize cooling systems, and kitchens are just a few items that a cost segregation specialist looks for when working to identify a tax savings in your apartment building.
The personal property assets are grouped under several IRS classifications. The cost segregation specialist identifies which components of each system, according to federal tax laws, can be assigned accelerated life of 5, 7, or 15 years rather than the straight line of 27.5 years. Cost segregation studies should be initiated as early as possible during the acquisition process to obtain the maximum tax savings.
Eugene Vollucci states, "by maximizing the deduction for depreciation, you in-crease your after tax internal rate of return (IRR). That’s the money you put in your pocket without the IRS going in after it".