| Income taxes are a substantial burden for | | | | cost basis to 5, 7 and 15 year property. In |
| business owners and real estate investors. There | | | | addition, real estate owners can "catch-up" |
| are few actions which can reduce your 2006 | | | | depreciation under reported in prior years without |
| taxes after December 31, 2006. This article | | | | filing amended tax returns. |
| summarizes four options for reducing your 2006 | | | | Fixed asset audits can be a cost effective means |
| federal income taxes during 2007. | | | | to increase operating expenses by removing |
| These include reducing revenue, increasing real | | | | phantom assets, removing operating expenses |
| estate depreciation, increasing expenses by | | | | mistakenly coded as capital expenditures and |
| conducting a fixed asset audit and increasing | | | | correcting the depreciable life for incorrectly |
| expenses by converting capital expenditures into | | | | coded items. Phantom assets can include assets |
| operating expenses. | | | | which have been lost, stolen or disposed of |
| The basic process for calculating income taxes is | | | | without removing them from the accounting |
| simple: | | | | records. The undepreciated basis of these assets |
| Revenue - expenses = net income, or taxable | | | | can be converted to an operating expense after |
| income, | | | | the error is discovered. In some cases, substantial |
| Taxable income x tax rate = income taxes | | | | operating expenses are incorrectly added to the |
| Two options for reducing income taxes are to | | | | fixed asset listing as capital expenditures. This |
| reduce revenues or increase expenses. It is not | | | | could include items such as substantial roof repair |
| possible to change the tax rate except through | | | | or parking lot repair. The undepreciated basis of |
| congressional action. It may be possible to reduce | | | | these items can be converted to an operating |
| revenue for taxpayers on an accrual accounting | | | | expense and written off when the error is |
| system. Taxpayers may be able to increase | | | | discovered. The fixed asset listing is massive for |
| expenses by increasing real estate depreciation, | | | | many companies, sometimes exceeding 1,000 |
| personal property depreciation or operating | | | | pages. With so many assets, it is difficult to |
| expenses. | | | | ensure all are accurate. For items added with an |
| Accrual accounting recognizes revenue when it is | | | | incorrect and excessive depreciable life, it is |
| earned. Cash basis accounting recognizes revenue | | | | possible to revise the asset life and "catch-up" |
| when payment is received. Accrual basis | | | | depreciation under reported in prior years without |
| taxpayers can review revenue which has been | | | | filing an amended tax return. Instead, a form 3115 |
| booked but not yet received. In some cases, it | | | | is filed with the tax return. |
| may be appropriate to increase the allowance for | | | | The difference between capital expenditures and |
| bad debt. There is little cash basis taxpayers can | | | | operating expenses is often subjective. Are |
| do to reduce revenue (after the end of the year). | | | | substantial roof repairs a capital expense or an |
| Most real estate owners can sharply increase | | | | operating expense? Reviewing disbursements |
| depreciation by obtaining a cost segregation study. | | | | which were listed as capital expenditures in 2006 |
| Real estate depreciation schedules are typically | | | | may uncover items which can be converted to |
| established by simply separating land and long-life | | | | operating expenses. |
| property. Long-life property is depreciated over | | | | Federal income taxes are a substantial expense |
| 27.5 years for rental residential property and 39 | | | | for successful businesses. Tax planning is less |
| years for commercial property. However, a | | | | glamorous than purchasing a new company or |
| subtantial portion of the depreciation schedule | | | | developing a new division. However, a modest |
| should be established as short-life property. It is | | | | effort focused on reducing federal income taxes |
| usually possible to allocate 20% to 40% of the | | | | can sharply increase net income. |
| cost basis to short-life categories. Cost | | | | Patrick O'Connor, MAI is president of O'Connor |
| segregation can usually increase depreciation by | | | | & Associates, a 180-person real estate |
| 50% to 100% during the first five to seven | | | | services firm in business since 1974. |
| years of ownership by allocating a portion of the | | | | |