Jerry Ferch
Jerry Ferch is president of www.CutFedTaxes.com
jerry@CutFedTaxes.com, Phone: 214-986-0920
jerry@CutFedTaxes.com, Phone: 214-986-0920
A Competitor Gives Really Stupid Advice
When we read something, we all tend to believe it. Don’t we? Isn’t it human nature to accept the written word to be true? I think so, which is why the subject of this article is sooooooo amazing.
Right now, at this very moment, there is an article written by the president of one of our competitors that is giving crackpot advice that violates U.S. Tax Law. The article is couched with a description that suggests it is one of those little known facts, kind of like the secrets that “they’ (whoever “they” are) never tell you that (if you only knew!) could save you millions. The trouble with this particular “secret” is that it is SO BIG of a secret, that it is illegal. If someone selling you cost segregation tells you to do this, just walk away.
The story goes like this:
- A person owns commercial real property which cost them, say, $3,900,000 to buy eight years ago.
- The person sells the property.
- Miraculously the person now can save big bucks by doing cost segregation after they’ve sold the building!
What? How? The article goes on to explain that the building owner had not previously done cost segregation, which means they were just depreciating the building @ 39- year straight line, which is $100,000 per year for eight years totalling $800,000. By doing cost segregation right before the building got sold, the owner was able to justify another $611,000 in depreciation that should have been taken during those same eight years, which he is now able to take as a subtraction from income for the current year. At a 35% tax rate, that depreciation reduces the owner’s income taxes by $213,850! The article goes to say that, after the sale of the building the owner only has to pay capital gains tax on the recovery of the depreciation, which is taxed at a 15% rate. This means that the owner only has to pay $91,650 in taxes on the recovery of the same amount of money that saved him $213,850, which means the owner pocketed a cool $132,200 on his little tax rate arbitrage trick. Pretty nifty, huh?
NOT! The Internal Revenue Service is not that stupid
U.S. tax law requires that, when a property is sold, all depreciation must be recaptured back to the original purchase price of the asset. All depreciation declared as 39-year straight line gets recaptured at a favorable rate of 25% and everything else gets recaptured as ordinary income at regular income tax rates. There is no such thing as the tax rate arbitrage described above and anyone saying otherwise is either lying, misinformed or clueless. The owner of a building will derive little or no benefit from the above described strategy. The only party who will benefit is the company that sold the cost segregation study!
There are, however, more complicated strategies whereby a property owner can justify that their 5-year and 7-year property has a lower liquidating residual value than its purchase cost and, thus, the payment received when the property is sold ends up being allocated in such a way that recovery of depreciation on the short term assets is less and more money shifts to being allocated against the building purchase, resulting in a net cash positive, but that is a much more sophisticated strategy requiring expert appraisals in order to pass IRS muster (and we are qualified to do this sort of thing for you, by the way).
There is, again, no truth to these stories of a simplisticly huge payout from cost segregation due to a “tax trick” taken after the sale. Cost segregaton offers an extraordinary opportunity to better manage taxes for nearly any commercial property owner. It does not require gimmicks to be a smart strategy for you – it just requires that you do it right. We will do your cost segregation the right way and we will advise you in a manner consistent with the tax code. Call us or email and we can engage in a quality converstaion to explain it all to you.