“In every country I’ve been in, real estate is the best tax shelter,” said Tom Wheelwright, CPA, an advisor and speaker at Robert Kiyosaki’s Rich Dad Poor Dad seminars, and a contributor to Donald Trump’s Wealth Builders Program. “Tax law is a series of incentives,” he said. “The big picture policy is that the government would like to encourage investment in real estate.”
And by owning real estate, you get to utilize what Wheelwright calls the king of all deductions, depreciation. “The number one benefit from investing in business or rental real estate is depreciation,” he said. “Say you paid $1 million for a building, including the land. Since the land doesn’t wear out, there’s no depreciation deduction for the portion of the price that relates to the land, but that leaves a large amount of the price related to the building [typically, 80 percent] to depreciate every year.”
“The tax benefits of long-term real estate investing can be equal to or even greater than the cash flow and appreciation from the properties,” said Wheelwright.
And what’s magic about depreciation, observed Wheelwright, is that you get a depreciation deduction for the entire cost of the building, even if you borrowed all the cash to pay for it from someone else.
And it gets even better. “When you buy the building, you also buy its contents, including floor coverings, window coverings, and cabinetry, as well as outdoor items such as landscaping, fencing and the parking lot,” he said. “This is important because these items can be depreciated even faster than the building itself.”
“Breaking out the component parts of a building, or cost segregation, is specifically sanctioned by the IRS, and technically required by law,” said Wheelwright. “But most CPAs merely split out the building and the land, and whatever equipment the taxpayer purchased after they bought the building.”
Cost segregation requires an analysis by a CPA or an engineer, Wheelwright indicated. “At my CPA firm, we use both an engineer and a CPA to do the cost segregation study. And since cost segregation can be done at any time, it can be done in a year when you are in the highest tax bracket.”
Clients should never do a cost segregation study on their own, Wheelwright said. “Have another CPA or an engineer do the study. Make sure that’s their specialty, and it’s all they do. It’s not expensive, and it should be done if the plan is a long-term investment strategy.”
When you do a cost segregation on a building you have owned for several years, you have to file a Form 3115 (Application for Change in Accounting Method) because you’re going from an incorrect method to a correct method of accounting, Wheelwright noted.
Once the investor holds the property for several years and sees the value increase, he may be tempted to sell the property and enjoy the benefits of his investment. But, said Wheelwright, “Why would you ever want to sell?” With a properly structured like-kind exchange, if you replace a new property with yet another property and continue to do so until you die, you may never have to pay any taxes.
“If you sell the day before you die, you will have a huge amount of depreciation recapture, but if you die first, there will be a step up in basis so that all the depreciation gain goes away forever,” he added. “You will have received all the depreciation deductions without ever paying tax on the gain when the property is sold.”
