| Investment real estate provides different things for | | | | walkways, driveways, swimming pools etc. So just |
| different investors. Some buy real estate for the | | | | how much chattel is there in a rental property? A |
| hopes of appreciation, some investors buy real estate | | | | conservative amount to use is 10% of the purchase |
| for monthly cash flow, and still others purchase | | | | price. Many times, this percentage is much higher. Let's |
| investment real estate for the tax benefits. There is a | | | | go back to our original example above and use a |
| large portion of the investment community that buys | | | | chattel amount of 10%: |
| for all of these reasons. So, what type of investor are | | | | Home Purchase Price: $200,000. |
| you? | | | | Land Value: $40,000. |
| Congress, along with the Internal Revenue Service, | | | | Chattel Value: $20,000. |
| provides a great many financial benefits for those who | | | | Building Amount to Be Depreciated: $140,000. |
| invest in real estate. From subsidized housing programs | | | | Let's now compute our new depreciation amount, |
| like Section 8 to the Gulf Opportunity Zone (GO Zone), | | | | including the value of the chattel: |
| real estate is as attractive an investment as it has | | | | Building Depreciation: $140,000/27.5 = $5,090.91. |
| ever been, thanks in large part to the federal | | | | Chattel Depreciation: $20,000/5 (years allowed) = |
| government. The tax benefits of investing in real | | | | $4000. |
| estate can oftentimes increase the ROI immensely. | | | | Total Depreciation: $5,090.91+ $4000 = $9,090.91. |
| Take a piece of rental property, for example. The IRS | | | | Additional Depreciation: $9,090.91 - $5,818.18 = $3272.73. |
| allows a multitude of tax deductions, including: | | | | By segregating the value of the chattel from the value |
| mortgage interest, travel, tenant background checks, | | | | of the building we earn additional tax deduction of |
| repairs, utilities, advertising, landscaping, pest control, | | | | $3272.73. Let's look at actual dollar savings: |
| professional fees and the list goes on. These are all | | | | Depreciation Amount: $5,818.18 x 25% Tax Bracket = |
| expenses as categorized by the IRS. Whenever you | | | | $1454.55. |
| have one of these expenses, you'll most likely write a | | | | Depreciation Amount with Chattel: $9,090.91 x 25% |
| check or use your credit card to pay for it. So if you | | | | Tax Bracket = $2272.73. |
| collect $1500 in rent, and then pay all of these | | | | Tax Savings: $2272.73 - $1454.55 = $818.18. |
| expenses, you may have $250 left over in your | | | | Keep in mind, these are conservative numbers. So, |
| account at the end of that month. That's not too bad | | | | now you may be thinking, what are the drawbacks? |
| when you invest in real estate for cash flow. | | | | You should always check with your tax adviser |
| There is however, another " expense", the IRS allows | | | | before employing a new tax strategy. The most |
| you to take. It is called depreciation. Although | | | | common question about chattel is the concept of a |
| depreciation is classified as an expense, you do not | | | | recapture and the recapture tax when you sell the |
| write a check to pay for it. Depreciation allows you to | | | | property. You may already be aware, you pay |
| spread the cost of the building out over a period of | | | | recapture with the straight-line 27.5 year depreciation. |
| time, and to take a portion of that purchase price over | | | | Recapture does also apply to the accelerated |
| that time. Commercial buildings typically have a | | | | depreciation taken through this tax strategy. |
| depreciation period of 39 years, while residential | | | | Let's talk briefly about recapture and the recapture tax. |
| buildings have a depreciation period of 27.5 years. | | | | A recapture tax is applied when ever a depreciated |
| Depreciation is considered only on the building, the cost | | | | asset is sold. The recaptured amount is subject to a |
| of the land has to be removed before calculating the | | | | maximum rate of 25%. The recapture tax percentage |
| annual depreciation. Let's look at example: | | | | rate is based on the investors’ income tax rate, |
| Home Purchase Price: $200,000. | | | | and is capped at 25%. This allows you to keep the |
| Land Value: $40,000. | | | | 75%, and utilize the Time Value of Money to create |
| Building Amount to Be Depreciated: $160,000. | | | | more investments. Let's use our example above, to |
| As you can see, we have a home purchase price of | | | | illustrate recapture. We will assume the investment |
| $200,000 and the land was valued at $40,000. What | | | | property was held for five years before being sold: |
| we subtract the $40000 land value from the total | | | | Home Purchase Price: $200,000. |
| purchase price of $200,000, we are left with a building | | | | Depreciation Taken: $9,090.91 x 5 (years) = $45,454.55. |
| value of $160,000. According to the current IRS rules, | | | | Home Sale Price: $250,000. |
| this $160,000 can now be spread out over 27.5 years. | | | | Recapture Tax: $45,454.55 x 25% (max rate) = |
| So take the $160,000/27.5 = $5,818.18 per year. | | | | $11,363.64. |
| The building is not the only part of your rental property | | | | How many additional properties could your purchase |
| that can be depreciated, however. The IRS Tax Code | | | | with $11,363.64 available before you had to pay it |
| also allows you to depreciate the "personal property", | | | | back? Is it one, three, or more? Remember, if your tax |
| called Chattel. In addition, the IRS allows you to | | | | rate is higher than 25%, you will keep the difference |
| accelerate this depreciation over a shorter period of 5 | | | | since you are cpped at 25%. This strategy also works |
| to 15 years. Let's look at a little bit of background on | | | | with multi-family properties as well. The savings with |
| how this IRS tax deduction came about. A court case | | | | multiple units multiplies greatly. If you own or are buying |
| called Hospital Corporation of America vs. Comm [109 | | | | a large multi-family property, ask your tax professional |
| TC 21 (1977)] makes all this possible. This case rules, | | | | about the Section 179 deduction. It provides over |
| that it is permissible to separate Section 1245 property | | | | $100,000 in deductions with specific criteria. |
| from Section 1250 property. Your CPA should be | | | | Now, the $50,000, which is the difference between our |
| familiar with section 1245 property and section 1250 | | | | selling price of $250,000 and our original purchase price |
| property. After this case was settled, the IRS issued | | | | of $200,000, is subject to capital gain. That is, unless |
| an Audit Techniques Guide ([ on cost segregation. In | | | | you have utilized another strategy such as the 1031 |
| this guide, the IRS describes several methods for | | | | Exchange or a Charitable Remainder Trust. The |
| determining the value of Section 1245 property. One of | | | | depreciation amount is not subject to capital gain. |
| the methods is the "Residual Estimate Approach.". | | | | Again, always check with your tax adviser before |
| Basically, what this allows a rental property owner to | | | | making a tax strategy decision. |
| do is segregate the value of the personal property, or | | | | Congress and the IRS have made real estate such an |
| chattel, and accelerate the depreciation on its’ | | | | attractive investment opportunity, it pays to utilize |
| value over a period of 5 or 15 years. | | | | every strategy available to maximize your cash flow |
| So what is chattel? The IRS has identified over 65 | | | | and lower your taxes. Ask your tax advisor about a |
| items that qualify as chattel, including: flooring, cabinets, | | | | chattel appraisal and a cost segregation study and |
| countertops, lighting, blinds, appliances, landscaping, | | | | start using the tax code to your advantage! |