Ninety Percent of Real Estate Owners Over-Pay Federal Income Taxes

RISMEDIA, March 30, 2006—At least 90 percent of commercial property owners are paying too much in federal income tax because they fail to take the tax deductions that are available on real estate, according to a study by O’Connor & Associates.
In analyses of property depreciation during the past four years, consultants found that at least nine out of 10 owners of commercial real estate were improperly reporting depreciation on federal income tax returns. As a result they paid too much in tax dollars, according to O’Connor & Associates, a Houston-based firm specializing in real estate appraisals, research, and state and federal tax reduction services nationwide.

IRS guidelines on depreciation are clear. They delineate which building components may be depreciated over a shorter life. The reclassification of short-life items into correct asset classes leads to higher depreciation and lower federal taxable income. However, many real estate investors and accountants disregard these IRS guidelines.

A 1997 landmark Tax Court decision, Hospital Corporation of America v. Commissioner, 109 T.C. 2, led to new IRS depreciation definitions for cost segregation.

“Owners and accountants have been slow to adopt these generous IRS depreciation procedures that are relatively new and not clearly understood,” said Patrick O’Connor, president of the firm. “Accountants are not equipped to directly provide this service and many owners do not understand that increasing depreciation typically shifts income taxes from ordinary income rates (35%) to capital gains rates (15%).”
IRS guidelines for cost segregation are similar to what was previously known as component depreciation. Designated portions of a property can be depreciated over 5, 7, or 15 years, versus 39 years for commercial or 27 1/2 for rental residential. As much as half of a typical property can be depreciated as a short-life asset, which can increase the depreciation by 50- 100%.

“In the next 5-10 years, property owners will increasingly adopt cost segregation to minimize federal income taxes,” O’Connor said.