The old west is known for its dynamic duos. Buffalo Bill and Anne Oakley. Frank and Jesse James. Earp and Holliday. John Wayne and Anyone. And of course, the most famous dynamic duo… cattle drives and beans. But there is one Dynamic Duo that is here today and can help ranchers and farmers in an amazing way.
Cost Segregation and Land Real Estate
Depreciation is a huge opportunity when owning income producing real estate. Depreciation can be used to shelter income from cattle or farming operations. What if there was a way to increase depreciation and shelter more income. That’s a good thing, right? Absolutely and that’s exactly what CS does.
So what is the first half of the Dynamic Duo, cost segregation? A cost segregation study (CS case study on Vermont family farm) is an engineered based study approved by Congress on each of the assets in a real estate transaction. This could be an irrigation system in a farm or a structure in a cattle operation to wiring in a building. The purpose of CS is to bring more accelerated depreciation to the property which will result in higher deductions in the early years of the business, keeping more money in the business owner’s pocket because of reduced taxes.
A cost segregation study can increase the rate of return which could help a farmer or rancher sell a property or make the property more attractive to buyers. At the same time, a CS study can help a seller because the study may be able to shelter more income which would increase the rate of return when that’s a main concern to a buyer. A good CS program can also lessen taxes because more depreciation shelters more income so there is less income to pay taxes on.
That’s the good news but now there is also some not so good news. When using cost segregation to accelerate depreciation, that depreciation must be brought back in for tax purposes when selling. Having said that, you can transact a 1031 exchange and defer the accelerated depreciation, but the accelerated depreciation will count against the replacement property that you buy so there will be less available depreciation. But don’t worry – there is still good news. If there wasn’t, there wouldn’t be a good reason to write this article.
Section 453 and Land Real Estate
The seller still has opportunities to defer the accelerated depreciation and that’s why Section 453 is the second half of the Dynamic Duo. Just call me Buffalo Bill…or John Wayne. Either works. What if you could use cost segregation to shelter income and reduce taxes and then defer the accelerated depreciation recapture tax for as long as the property owner would like.
Section 453 can be a great opportunity when the farmer or rancher wants to sell and retire or wants more real estate. If he wants to retire, our Section 453 tax deferral strategies can defer the capital gains tax, state tax, depreciation and accelerated depreciation recapture and the Obamacare tax on the gains on his sales proceeds for as long as he would like and the tax deferrals and the income generated from the deferred taxes can be passed on to his heirs. Also, by deferring taxes, the seller can generate a much larger lifetime retirement income than if he paid taxes first. Seller wins.
Let’s change gears and now the property owner wants to sell and buy another property. Our Section 453 tax deferral strategies can often work better than a 1031 exchange. Here’s why. When selling and using a 1031 exchange, you do not get a new depreciation schedule but rather, the non-depreciated portion of the original property plus the increase in the new property. For example, say the original property that is bought for $1 million is depreciated at 80% and sells for $4 million and using a 1031, a $5 million property is bought. The depreciation on the new property will be the 20% of the original property and $1 million on the new property. You can use a Cost Segregation Study, but the benefits will be limited because of the limited depreciation of the new property.
However, using our Section 453 proprietary trust, you can sell your property and then at any time in the future, buy another property of any kind for any price. Whether the new property is more than $4 million or less doesn’t matter. The property owner can defer the accelerated depreciation in addition to the capital gains tax, state tax, and the Obamacare tax on the sale of the old property and complete a new cost segregation study to shelter more income from the new property. Sheltering more income also reduces taxes and accumulates wealth. Another win for the seller, Buffalo Bill and John Wayne.
The bottom line is that the Dynamic Duo can be a great opportunity for brokers to help their clients keep more of their hard-earned money in their pockets and provides opportunities to reduce taxes and make properties more attractive when buying or selling. So, get to know the Dynamic Duo. Let’s call Groot to make us some beans but preferably without all the cattle. Best wishes and Happy Selling!
About the Author: David Fisher is the managing partner for Creative Real Estate Strategies, a national firm that can defer taxes on highly appreciated real estate when a 1031 isn’t appropriate or can’t be completed. He has been an RLI sponsor since 2006 and has sponsored over various RLI events nationwide. He can be reached at 713-702-6401 or firstname.lastname@example.org.