BE A TAX EFFICIENT REAL ESTATE INVESTOR
Engineered Tax Services provides the independent engineering analysis required for green certifications, energy tax credits and cost segregation studies. These combined services result in maximum efficiency and cost savings on the federal, state, local, and utility levels.
In the previous blogs, we have discussed cost segregation and how it evolves into the next generation of tax benefits. Ultimately, cost segregation is one aspect of tax efficiency that is related to real estate, but there is a host of other tax benefits associated with owning real estate that every investor should also be aware of today.
As we have seen, real estate is the only investment class where the government allows a gain in equity through the use of historical tax credits, facade easements, air rights, TIFFS, energy tax credits, conservation easements, affordable tax credits, and many other incentives. The government provides this equity freely, and the investor is then able to write off 100% of the building to minimize taxes and preserve wealth.
Real Estate Investment Example
A real estate investor buys a $10,000,000 property. The investor receives $3,000,000 in federal tax credits that he uses as his equity, securing 70% debt with no money out of pocket. The investor now does a cost segregation study and captures a $4,000,000 tax deduction in the first year alone. At a 50% tax rate, that is a $2,000,000 cash benefit on money saved. The investor also qualified for a much lower interest rate on the purchase since the property was energy efficient, which qualified for an additional tax deduction of $500,000 which is a $250,000 cash benefit.
Furthermore, the above investor also took a conservation easement on the land, promising the federal government he would conserve some of the acreages for wildlife. This netted the investor another $600,000 in cash.
In summary, the investor has a $10,000,000 building. No equity needed, provided by the government. The same property allowed him to take $4,500,000 in tax deductions (tax loss) to preserve $2,250,000 in cash and offset other taxes. It is easy for anyone to do this. Many don’t have the awareness to do so, otherwise, they would. Who wouldn’t? There is too large a percentage of tax advisors who miss these incentives due to either being overly conservative or a lack of awareness.
As you can see, our tax code is structured to help people and businesses reduce tax liability so that they retain funds for proper business operations, driving revenue into our markets via wages and purchases.
REAL ESTATE TAX CREDITS & DEDUCTIONS
We have discussed cost segregation’s impact on the disposition of assets, repairs and maintenance expenses, and energy tax deductions. Those are benefits to most real estate investors, but it is just a scratch on the surface. This section walks through a multitude of tax benefits that real estate investors utilize to maximize their wealth.
Energy Tax Incentives
Energy incentives were placed into service in 2006 by the government to inspire energy utilization and energy efficiency of buildings. It was designed to incentivize building owners to invest in energy-saving components by shortening the payback period for those investments. There are a number of state and local utility incentives available to property owners. Each case must be looked at for state and local incentives to determine the benefits.
Our team of energy experts utilize the most up to date database which identify these incentives and benefits in detail.
Historic Tax Credits
Another area where we find benefits is with income producing properties listed on the National Register of Historic Places. A Historic Tax Credit is essentially free equity that can be taken for improvements paid to restore these historic buildings. This federal income tax credit equates to up to 20% of the cost of rehabilitating historic buildings or 10% of the cost of rehabilitating non-historic buildings constructed before 1936. Meanwhile, the cost of the project must exceed the building’s adjusted basis.
Cost segregation can be used to bringing down the basis of a building so that the Historic Tax Credit can start with a lower threshold. For example, if a historic property was purchased for $1,000,000 and $200,000 is defined as personal property with a cost segregation study, then we can say the real basis for the property is $800,000. Once that $800,000 threshold is reached in terms of improvements, up to 20% of the associated costs can be taken under the Historic Tax Credit.
In the event that a property is sold and converted to cash, this credit is very impactful in terms of true equity for property investors.
Our State and Local Incentives Services can enable you to benefit from significant State and Local programs meant to incentivize targeted industry growth, and real estate development, preservation, restoration, and/or adaptive re-use. These programs represent an opportunity for you to recoup a portion of your business and real estate development costs and increase your overall tax efficiency and cash flow. Services include a full range of grant and tax credit research, and application assistance; including developing a list of potential grant-makers, tax credits, rebate programs, and alternative financing resources. ETS will conduct a State and Local Incentives Analysis and work with your development team to make a plan for applying to the relevant opportunities. ETS acts as the project lead to ensure the applications are completed on time and have the highest possibility of success. The most common incentives include historical, affordable housing, and sustainable design including multi-modal transportation.
Facade Easement Credits
Similar to the Historic Tax Credit, buildings that qualify under the historic register may also benefit from the Facade Easement Credit. The tax credit is designed to preserve the historic character of a building’s façade. In order to qualify, the building must be of historic value or be in a certified historic district.
This ensures the property preserves its historic character while providing a tax deduction for the owner.
These types of benefits are typically negotiated upfront with the local government and are best explored as part of your due diligence when looking for investment $10,000,000 building $4,500,000 in tax deductions $2,250,000 cash offset opportunities. The rules for this credit are technical enough that you will want to seek a professional’s help.
Airspace refers to the space above the surface of the ground; and more specifically, the space above a building from the roof up. This space is considered fillable, making it valuable equity for real estate investors who wish to purchase or sell a property that can be extended vertically.
Additionally, rights to that airspace may also be sold or purchased for further opportunity. Every property owner and investor should evaluate airspace rights as part of their due diligence process to avoid any surprises that may inhibit future development.
A conservation easement is a private action taken on private land, which provides for the preservation of the land by permanently restricting development, commercial and industrial uses, and certain other activities on a property.
With the proper application of a conservation easement, landowners can receive a deduction up to 50% of their adjusted gross income. Further, surplus conservation easement deductions can enjoy a carry forward life of up to 15 years.
In certain circumstance, farmers and ranchers can realize a deduction up to 100% of their Adjusted Gross Income. Additionally, these deductions are recognized in the majority of states that also collect income tax; some cities as well. If that were not enough, certain states like Colorado, Virginia, and North Carolina have at times offered tax credit incentives for land conservation, which in many cases may be taken in addition to the federal and state deductions. Landowners should always consult with a tax adviser to accurately depict the tax savings outcome.
Affordable Low-Income Tax Credits
The affordable low-income tax credit was developed to encourage private sector residential developers to build affordable housing. Tax credits are given to builders, who in turn sell them to investors to raise money for low-income housing. As long as the building continues to qualify, the investors can benefit from tax credits for ten years for each dollar invested. The property criteria must be a residential real estate, meet low-income tenant eligibility, and be rent controlled.
Bifurcation & Depreciation Strategy
When entering funds into a real estate partnership, the focus is typically on preserving the tax-exempt status for the public investors. This focus on the tax-exempt partner side of the arrangement can distract the typically smaller investor group, the taxable partners, from incorporating and maximizing their own tax opportunities into the partnership structure. Special tax allocations and accelerated depreciation deductions stemming from cost segregation studies are two examples of traditional tax savings strategies that are often overlooked or typically not thought to be beneficial due to the heavy concentration of tax-exempt partners within the structure. With proper tax planning upfront, both the tax-exempt and taxable partners can gain tremendous shifts up in the cap rate.
In general, the private tax paying investor group represents a smaller portion of traditional real estate investment groups. The cost segregation benefits this minority by generating greater depreciation deductions to reduce the tax on their rental income and, in some cases, reduce the tax on other income if they are considered active real estate investors. Tax-exempt partners, on the other hand, generally do not benefit from depreciation deductions. Thus, in some cases, the differing status of the two groups can present a prime opportunity to specially allocate the tax-exempt partners’ share of depreciation deductions to the taxable partners. By doing this intelligently, the tax-exempt partners can also greatly benefit due to the fact that this would dramatically reduce any back-end recapture to the tax-exempt entity upon the sale of the asset, which dramatically improves their return position.
Even though the investors within each fund have different tax structures and tax needs, the goal of enhancing each investor’s rate of return can be accomplished through sophisticated tax planning strategies. If properly structured, the tax-exempt and taxable partners may both benefit from special tax allocations to produce significant tax efficiencies.
Fannie Mae & Freddie Mac. Loan Energy Discount Programs
As a way to incentivize multifamily investors to save energy or water through property improvements, Fannie Mae and Freddie Mac have developed a Green Advantage program. This program offers a reduced interest rate loan program for new acquisition, refinance, or properties that are already green certified. By committing to reduce energy or water consumption by at least 15%, you may get better pricing and more funding to make the enhancements to the property.
Brownfield Cleanup Program
A brownfield site is any real property where a contaminant is present at levels exceeding the soil cleanup objectives or other health-based or environmental standards. The goal of the Brownfield Cleanup Program (BCP) is to encourage private-sector cleanups of brownfields and to promote their redevelopment as a means to revitalize economically blighted communities. The BCP is intended to remove some of the barriers to and provide tax incentives for, the redevelopment of urban brownfields. These tax incentives allow for the environmental cleanup costs of eligible properties to be fully deductible for the year incurred. Meanwhile, previously filed tax returns may ben be amended to include deductions for past clean up expenditures.
DEIRA – Insurance Replacement Appraisal
An insurance appraisal is a replacement cost analysis which provides an accurate estimate of the amount of insurance required to replace each structure exactly as it stands on the day the report was prepared. Most property owners, managers, boards, and insurance agents believe that obtaining an insurance appraisal for their property is one of the best decisions they have ever made.
It takes the guesswork out of a property valuation by providing a detailed analysis of the actual cost to rebuild or repair an insured property, reducing premiums and obtaining better terms, conditions, and coverage for the property owner.
Although a taxpayer may want to demolish an existing property, it may hold many items that can be recycled and reused by another organization such as Habitat for Humanity. Several charitable organizations across the country accept used materials from investment properties such as cabinets, appliances, doors, light fixtures, siding, roofing windows, flooring, etc. The process of deconstruction and subsequent removal of charitable materials from investment prosperities is great in terms of greening the community and the process also allows for significant wealth preservation.
The following steps are necessary for the charitable contribution process:
The taxpayer will need the donated materials valuation form 8283 from the engineer and must attach it with the appraisal to the tax return as support for the charitable deduction. Engineered Tax Services also provides the taxpayer with a partial disposition report to maximize the benefit.
- A licensed engineer will inspect the property prior to demolition to determine all the materials that would be eligible for donation. They will then calculate the remaining tax value of assets being removed that will have no charitable value but will qualify as a partial disposition expense.
- Have your contractor add about 5% additional labor to provide deconstruction of charitable assets within your facility.
- The taxpayer will need the donated materials valuation form 8283 from the engineer and must attach it with the appraisal to the tax return as support for the charitable deduction. Engineered Tax Services also provides the taxpayer with a partial disposition report to maximize the benefit.
All of the tax advantages listed in this articles are available to real estate developers and investors. When combined, these smart real estate investments serve as a valuable tax tool for wealth preservation.
To learn more, contact the professionals at Engineered Tax services today!