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