Huge Refunds for Residential Real Estate Investors
- Donald Feicht
- Mar 25
- 6 min read
As residential real estate investors, understanding tax benefits can significantly impact your bottom line. One of the most beneficial yet often overlooked avenues is the potential for huge refunds due to under-deducted depreciation. In this blog post, we will explore how to tap into these refunds, the benefits they offer, and some practical steps to enhance your investing strategy.
The Importance of Depreciation for Real Estate Investors
Depreciation is a non-cash deduction that allows property owners to recover the cost of their investment over time. The IRS dictates that residential rental properties can be depreciated over 27.5 years. This means that each year, investors can deduct a portion of the property’s value from their taxable income, reducing their overall tax liability.
However, many investors fail to maximize these deductions, leading to under-deducted depreciation. When this occurs, investors miss out on substantial potential refunds. Understanding how to correctly compute and claim depreciation can open the door for refunds that could significantly enhance your cash flow.
Unlocking Huge Refunds
When capitalizing residential rental real estate, it is still a standard practice to subtract the non-depreciable land value from the acquisition cost and depreciate the remaining value of the improvements over 27.5 years. This is not a fault of the accountants as there was no dependable way to further detail the depreciable assets.
Today, due to advances in technology and the wealth of information available on the internet, programs like REALTAX SAVER are available to perform very accurate cost segregation studies to reclassify many components of a real estate transaction into accelerated depreciation classes of 5-year, 15-year, and 27.5-year property for depreciation purposes.
A cost segregation study is the most effective and accurate way to enhance depreciation deductions and boost cash flow. Cost segregation is the process defined by the Internal Revenue Service for categorizing assets into groups such as real property, personal property, and land improvements.
Making the Case, An Actual Case Study
Mark H. purchased a single-story ranch house in Pueblo, New Mexico, in March 2019 for $435,000. In addition to the purchase price, Mark also paid legal fees of $720 and incurred $1,100 in repair costs to paint the front door and install new locks, bringing his total initial investment to $436,820.
Mark's accountant determined the market value of the land was $115,000 according to the local assessor and deducted the land value from the $436,820 acquisition cost, then proceeded to capitalize $321,820 of depreciable value for 27.5 years (approx. $11,720 per annum).
Purchase Price | $435,000 |
Legal Fees | $750 |
Repairs | $1,100 |
Total Cost | $436,820 |
Land Value | $115,000 |
Depreciable Assets Value | $321,820 |
Annual Depreciation Deduction | $11,700 |
While reading investment articles, Mark learned about cost segregation, a strategy to reduce income taxes by accelerating depreciation on property components. Intrigued, he consulted REALTAX SAVER, a firm specializing in cost segregation tax-saving strategies.
The REALTAX SAVER analysis revealed that 18% to 28% of the cost might be eligible for this treatment, allowing him to write off costs over a shorter period than the standard 27.5 years.
The completed analysis indicated:
Acquisition Coat | $436,820 | ||
Land Value | $115,000 | ||
Depreciable Assets | $321,820 | ||
Component | Depreciation Basis | Depreciation Method | 1st Year Depreciation |
Buildings | $209,183 | 27.5 Year S/L | $7,607 |
Personal Property | $67,582 | 5-Year 200% DDB | $27,033 |
Land Improvements | $41,837 | 15-Year 150% DDB | $4,184 |
Total Depreciable | $321,280 | $39,874 |
If a cost segregation study had been implemented when the property was originally capitalized, the first year depreciation deduction would have risen to $39,874 from #11,700.
Fortunately, there is a way to recover those unclaimed depreciation deductions using a "Look-back" procedure.
The Internal Revenue Service allows taxpayers to accumulate any unclaimed depreciation from prior years' tax filings and take those deductions in the current tax year. This can all be done without the need to file amended returns, but by simply filing for a change of the basis for the under-depreciated components.
Mark was able to claim $122,748 in depreciation deductions for the current tax year. That included the current deductible amount plus five years of unclaimed deductions from the accelerated depreciation of 5-year and 15-year components not previously reported.
Current Tax Year without cost segregation | $11,700 |
Current Tax year after REALTAX SAVER analysis | $122,748 |
Current Year Depreciation Deduction | $111,045 |
Additional Cash Flow at a 30% Marginal Tax Rate | $33,000 |
At an estimated marginal tax rate of 30%, that increase in depreciation represents an additional approximate $33,000 in cash.
Achieving huge refunds from under-deducted depreciation is not as complicated as it may seem. First, it is essential to assess your previous tax filings to identify any discrepancies in the depreciation claimed. If you have been under-deducting your depreciation, you can file for a change of basis and capture any under-reported depreciation in the current year.
To unlock these refunds, consider working with a tax professional who specializes in real estate. They can help navigate this complex area, ensuring that you follow regulations while maximizing your deductions. In some cases, it may be possible to go back several years to amend tax returns, potentially leading to significant refunds.
Benefits of Huge Refunds
Enhancing Cash Flow: The most immediate benefit of these refunds is increased cash flow. When you receive a refund, it can free up cash that can be reinvested into your property portfolio.
Expanding Your Real Estate Portfolio: With additional funds, you can purchase more properties or upgrade your existing ones. This reinvestment can lead to long-term capital growth and increased rental income.
Emergency Cash Reserve: Unexpected expenses are par for the course in real estate. A significant tax refund can serve as a safety net, allowing you to handle repairs or vacancies without derailing your financial plan.
Saving for Future Investments: Rather than spending your refunds immediately, consider investing that money strategically. Explore opportunities like real estate syndications, which can grow your capital exponentially over time.
Action Steps to Address Under-Deducted Depreciation
Now that you understand the importance of depreciation and the potential for refunds, what can you do? Here are some actionable steps:
Review Past Returns: Start by reviewing your past tax returns. Look for any missed depreciation claims. Keep an eye on the cost basis of your properties, ensuring that you are using the correct figures.
Consult a Tax Professional: This step is vital. Tax laws can be tricky, and doing it alone may lead to further complications. A tax pro with real estate investment experience can help you accurately determine the appropriate deductions.
Consider Cost Segregation Studies: This is a more advanced strategy where certain components of a property are reclassified to shorten depreciation times. While it involves upfront costs, the long-term benefits often outweigh these initial expenditures.
Stay Informed: Tax laws can change, so it is necessary to stay updated on any changes that might affect depreciation calculations. Regular discussions with your tax advisor will help you navigate these changes.
Expanding Your Cash Savings
The benefits of claiming huge refunds go beyond simply enhancing cash flow. Increased cash also contributes to your savings. With more funds available, you can bolster your emergency reserve or invest in other avenues that contribute to your long-term wealth creation.
Effective cash management allows investors to balance their portfolios, handle unexpected situations, and even explore new opportunities. By taking advantage of tax refunds and strategically reinvesting them, you create a stronger financial position, giving yourself more flexibility and security.
Real estate investment is about making informed choices. Tactical decisions around maximizing your tax benefits can create extensive financial opportunities.
The Bigger Picture: Wealth Building through Real Estate
In summary, the potential for huge refunds from under-deducted depreciation is a significant opportunity that every residential real estate investor should embrace. By reevaluating your past returns, consulting with professionals, and utilizing strategies such as cost segregation studies, you can open doors to a wealthier future.
Furthermore, the benefits extend beyond immediate cash flow. You’ll be able to reinvest in new properties, prepare for emergencies, and save for future investments. These factors combined create a robust strategy for real estate investment, helping you grow your portfolio, build wealth, and achieve long-term financial stability.
It's time to take the necessary steps to secure those refunds and unleash the hidden potential within your real estate investments. Don't let under-deducted depreciation stall your growth. Start today, and watch as the cash flow from refunds enables a brighter financial future.
By understanding the significance of depreciation in your real estate journey, you're not only becoming a savvy investor but also positioning yourself for enormous financial rewards. Act now to claim what you deserve and pave the way for a secure, successful investment trajectory.
The information provided here should not be interpreted as legal or accounting advice and should only be used after the reader has conducted their due diligence to apply the advice to their specific situation. d.f.feichtco LLC (440) 240-8251
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