How to maximize deductions for business real estate

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Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is extended, and the land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.

Segregate personal property from buildings

Buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of structures or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phase-out if total asset acquisitions for the tax year exceed $2.03 million).

If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, things you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems may be eligible.

Carve out improvements to land

As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the property itself by identifying and documenting those upgrades can provide depreciation deductions. Typical examples include landscaping, roads, and, in some cases, grading and clearing.

Convert land into a deductible asset

Because the land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit of depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.

Another option is to purchase an “estate-for-years,” under which you own the land for a set period, and an unrelated party holds the interest in the property that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.

More limits and considerations

There are additional limits and considerations involved in these strategies. Also, keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.

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Taxpayers don’t have to pay self-employment tax on an amount deemed to be rent paid to their chicken farm. The U.S. Tax Court ruled that a corporation, which paid its married sole shareholders both rent for farmland and wages for work they performed on the farmland, didn’t owe self-employment tax on the rent. The couple entered into an agreement with a large poultry producer, which paid rent to the business. The decision reverses the court’s holding in previous similar cases and follows the reasoning of the Eighth Circuit Court of Appeals. (149 TC No. 12)

Deductions must Be Proven

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Where’s the proof? Taxpayers engaged in business may be able to deduct reasonable business-related expenses from their gross income, if they provide adequate proof. The IRS denied most of the deductions claimed by one married couple, citing a lack of substantiation. This included utility costs, which weren’t proven to be business related, and mileage logs, which lacked sufficient detail, such as the business purpose of trips. The IRS did allow a deduction for the cost of a messaging service related to the husband’s business. (TC Memo 2017-173)

What’s up with health care reform?

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President Trump has been prodding the Republican-led U.S. Congress to pass a major health care law, but huge obstacles remain, as key Senators voiced pessimism about the chances of repealing the Affordable Care Act. Sen. Pat Toomey (R-PA) said a new version of the Senate bill is expected to be released soon and that “there’s a shot” of getting to the 50 votes needed to win passage in the 100-seat Senate. However, other Republicans were more pessimistic. Sen. John McCain (R-AZ) said the legislation is “probably going to be dead.”