With over 20 years of experience as a CPA, I have found the most successful client/CPA relationships are the ones where conversations occur throughout the year. Too often, people speak with their CPA only once a year, when it is time to provide the annual tax information. At that point though, it may be too late for effective tax planning and discussions.
Maintaining a year-round relationship with your CPA is a great way to make sure you’re not leaving money on the table. It is easy to assume that your CPA knows all the applicable rules and is applying them correctly to your real estate business. However, tax law has become increasingly complex over the past several years. It can be difficult for CPAs to keep up, especially if they are generalists and do not specialize in a particular area of taxation.
To help you navigate conversations with your CPA, I’ve put together the list of topics below that you should be discussing with your CPA on a regular basis.
Should I Get a Cost Segregation Study on My Property?
Cost segregation is an excellent tax planning strategy to accelerate deductions on real estate that has been purchased, constructed, or remodeled. Through a cost segregation study, you can break out Personal Property and Land Improvements, which will have a shorter life than the overall building structure. Personal Property has a tax life of five or seven years, while Land Improvements have a tax life of 15 years. In addition, with bonus depreciation, you can depreciate up to 80% of the asset in the first year if placed in service during 2023. However, under current law, bonus depreciation will reduce 20% per year until it sunsets in 2027.
Cost segregation studies can even be performed on property that was purchased and placed into service in prior years. The difference in depreciation between what has been taken and what would have been taken if the shorter lives were used from the beginning is run through the current year return as a change in accounting method.
Ask your CPA if a cost segregation study might be beneficial to your property.
Which Improvements to the Property Are Capitalized and Which Are Expensed?
In 2013 the IRS issued guidance that clarifies when expenditures should be capitalized as improvements or expensed as repairs. Under these rules, many items that would have been capitalized in the past can now be expensed in the current year as a repair.
To properly analyze expenditures each year, your CPA should be having conversations with you to better understand this scope of work. A qualified CPA will ask questions and request information to expense items that are more accurately classified as repairs for tax purposes. Through this analysis, immediate deductions can be taken where appropriate. In addition, by expensing repairs rather than capitalizing them, you will not have depreciation recapture upon the sale of the property. This can reduce your taxes overall.
Check in with your CPA regularly about which improvements can be capitalized and which can be expensed.
Is My Entity Subject to Business Interest Limitations?
In 2017, The Tax Cuts and Jobs Act included a change in the rules which places limitations on the ability to fully deduct interest for certain taxpayers after December 31, 2017.
Prior to 2022, business interest expense was limited to 30% of Adjusted Taxable Income (ATI). ATI was, simply stated, your taxable income plus depreciation, amortization, and interest expense. Starting in 2022, you cannot addback depreciation and amortization in calculating ATI. Thus, ATI is expected to substantially decrease, resulting in your interest limitation increasing.
Certain taxpayers are not subject to these rules. However, the determination of whether you are exempt from the rules is complex and I have found they are often misinterpreted. Taxpayers in the real estate industry need to have annual conversations with their CPAs to determine if these rules impact their business and decide on best recommendations.
Would a Like-Kind Exchange Help Diversify My Real Estate Portfolio?
Like-kind exchanges are a great tax planning strategy. These exchange tax rules have been around since The Revenue Act of 1921, although in practice farmers exchanged land and livestock well before then.
The ability to sell a property and purchase another without paying tax is a valuable tax planning strategy. With the flexibility of the law, you could sell one property and buy more than one replacement property. In addition, there is no limit to the number of like-kind exchanges; thus, you can continually exchange properties over time. If you have a property that you are considering selling, talk with your CPA about the like-kind exchange rules and whether they would be a good tool in deferring taxes.
Are Net Losses from My Real Estate Activities Able to Offset Other Items of Income?
Taxpayers must pass several hurdles to deduct losses from real estate activities.
First, you must have sufficient tax basis. In simple terms, basis is your cumulative investment plus any liability allocation, adjusted for cumulative income and deductions. Second, the basis must be at-risk. This means that you need to, essentially, be on the hook for any liabilities allocated to you. Third, you must determine if the loss is passive. Passive losses are generally limited to passive income.
Once you have cleared the first three hurdles, you must jump the final hurdle of “excess business losses.” A fairly new rule, the excess business loss rule limits the loss from business income that you can take in a year. Any excess losses are carried over into future years as a net operating loss. In 2022, the limitation is $270,000 for single filers and $540,000 for joint filers. This amount is indexed for inflation each year.
The rules determining ability to deduct losses are complex and specific to each taxpayer’s personal situation. Make sure you are discussing your activities and ability to take any losses with your CPA on an annual basis to ensure that losses are properly deducted.
Working with your CPA throughout the year, rather than just during tax season, can help you maximize the money saved in your wallet. Visualizing your tax responsibilities and assets earnings/losses may be daunting, but with these questions, you can build a stronger, more profitable relationship with your CPA. Keep an eye out for more “Ask Your CPA” articles coming this year! And send me an email if you’d like to discuss any of the topics above.
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