In this episode, we're joined by Kevin Jerry, EVP at Cost Segregation Services Inc to discuss the Tangible Property Regulations including safe harbors, partial asset dispositions, and how they intertwine with cost segregation studies, as well as the real estate professional status (REPS)and common misconceptions.
Kevin focuses on real estate taxation, cost segregation, and the tangible property regulations (TPRs). Kevin also presented at the 2020 Tax and Legal Summit where he spoke in depth about the tangible property regulations.
Impactful Takeaways from the TPRs
If any expenditures are on a depreciation schedule, you can go back with a negative 481(a) adjustment and get that those expenses off of your depreciation schedule. Many CPAs ignore that. Often, these are expenses/improvements that were made 10, 15, and 20 years ago that could now be treated differently. Even if there's no basis left to depreciate, removing these expenses from the schedule will provide that there's no depreciation recapture for those amounts at sale. These amounts drop your basis and decrease capital gains. This is now a law, this must be done or you're not compliant. Failing to follow the TPRs since they have been in place will result in penalties and IRS attention.
De Minimis Safe Harbor
This safe harbor applies to expense items that are under $2,500 per invoice line item. This is a low-hanging fruit safe harbor that everyone is taking advantage of. If you're a large corporation and your average expenditure is higher, it is possible to have a higher de minimis safe harbor. The onus is on the taxpayer to prove that average expenditures are typically much larger than $2,500.
Small Taxpayer Safe Harbor
This is designed as an administrative convenience to not burden small taxpayers. Taxpayers can take the lesser of 2% of the building's unadjusted basis or $10,000 for each building and expense whatever the taxpayer desires. Routine maintenance is included, anything that will be done again in 10 years or less, and can be expensed.
Routine Maintenance Safe Harbor
Expenses that qualify as routine maintenance under this safe harbor are currently deductible regardless of cost. There are no annual dollar limits and any landlord can use this safe harbor regardless of income levels.
Routine maintenance is recurring work a landlord does to keep an entire building, or each of the building’s nine systems (units of property), in ordinarily efficient operating condition.
Partial Asset Disposition
For example, you have a building and you're doing a renovation. You're taking a portion of the asset and disposing of it during this process. The items or materials you dispose of may not have value to the investor or the building. From a tax standpoint, the basis can be reduced. You can take a one-time expense and write down all of the old materials that were disposed of. A value cannot be placed on this unless a cost segregation has been performed. The general contractor needs to separate the cost of materials, disposal and removal from the cost of the new additions and materials.
17:00 If you're doing a major renovation, you want to identify the cost breakdown of some items that you'll be disposing. If you're doing major renovations, you want to keep the cost segregation company involved and document everything that has been done. However, Kevin notes that a cost segregation should be considered when it is most useful. There may not be a general "best time" to execute a cost segregation study, it depends on the situation of each taxpayer - when do you really need to use those losses?
Real Estate Professional
This designation and portion of the tax code is widely misunderstood. Many may assume that they qualify due to the time they spend or the value of their assets.
Education, Training, and Research (books, podcasts, seminars): This time spent does not qualify. No education or training time qualifies. Time spent reviewing financials, analyzing a mortgage, researching cheaper debt, or speaking with a bank about restructuring also does not count towards the hours requirements. Researching properties or searching for new properties to acquire does not count. However, you can expense the time spent researching under the TPRs. The time just doesn't count towards material participation hours.
To qualify as a real estate professional, you must actually become a real estate professional doing real estate for a living! You must have a real property trade or business and rental properties count. You must spend at least 750 hours managing the properties directly.
- Commuting time and driving time does count
- Performing repairs and maintenance, such as fixing a gutter or shoveling snow
- Hiring and supervising contractors
In addition to the 750 hours, you must spend at least 50% of your personal service time managing the rentals. This virtually excludes those with W2 jobs. You have to materially participate in each rental, unless you elect to aggregate all rentals to be treated as one.
Using the link above will send your information directly to Kevin for his review. Kevin will look at the depreciation schedule, look at expenditures, and calculate the accelerated depreciation lives. Kevin may call for additional details, such as your tax bracket, specific line items, and a cash flow analysis of the tax deferral.
Kevin's personal phone number and email address are included at the very end of the episode and in the Soundcloud description. We don't put this information in the notes so bots don't spam him.