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Chattel Professionals, LLC are not CPAs or attorneys. Always
check with your tax and legal advisors.
Use our information to initiate discussions with your CPA
or tax attorney about your individual situation.
You are welcome to have your accountant call us! 888-844-1390
In real estate, “chattel” means moveable,
personal property. Generally, this means things
in or on a building or land that can be removed
without damaging the structural integrity of the
building. Even in an empty building, there are over
50 examples of items that can be considered personal
property, or chattel. But IRS regulations are not
always intuitive. For example, a water heater is
chattel but a furnace is not! Linoleum is chattel
but tile is not!
There are four elements to any property:
1. Land
2. Land Improvements (fences, for example)
3. Building
4. Chattel
Properly valuing these four elements can mean the
difference of 1000’s of dollars in your pocket.
Your CPA rarely has the time, correct information
or knowledge to attribute correct values to each.
And the IRS prefers valuations to come from an objective,
third party. Do you want to be paying your accountant
for his or her time to make challengeable estimates
when a cost-effective, 1x, tax-deductible fee to
Chattel Professionals can give you an accurate,
supportable document that provides a number of other
benefits as well? |
| Who benefits from a chattel report? |
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Real Estate Investors
If you are a taxpayer who owns property that produces income,
you stand to get a considerable boost in savings from a
chattel valuation. Anyone who is about to acquire or construct
a property should plan a chattel valuation into the calculations.
Chattel valuations are not beneficial if you plan to keep
a property for less than one year.
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A chattel report:
Improves cash flow
Reduces net taxes
Accelerates legal, underused depreciation
Saves time during an audit
Provides accurate documentation of personal property
Provides independent verification of property values
and deductions
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Accountants
Accountants benefit from a third party report that provides
financial data on their clients’ properties. This
adds accuracy, saves time, and mitigates audit risks. As
trusted financial advisors, accountants can provide maximum
savings for their clients by recommending a chattel appraisal.
Realtors & Developers
Through tax savings, a chattel report can turn a cash
flow negative to a positive, enabling clients to purchase
a property they might not have. Realtors often purchase
chattel reports as thank-you gifts for clients, who will remember the realtor very warmly each year on tax day (much more effective than home warranties!).
Service Providers to the Real Estate Industry
Real Estate Attorneys, Mortgage Brokers, Property Managers,
Insurance Providers, Real Estate Clubs & Networks, Title
Companies – anyone who provides services to real estate
owners can use chattel reports to differentiate themselves
and provide added value.
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| My accountant takes care of this already. |
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Accountants are a valued part of your team. So when we learn
about cost segregation, we naturally assume that our accountants
must be performing it. The reality is that this is rarely
the case. Your accountant is likely familiar with the approach
but hesitant to take the savings without an independent
documented analysis that supports the depreciation schedule.
The IRS issued a chief counsel advisory warning that an
“accurate cost segregation study may not be based
on non-contemporaneous records, reconstructed date or taxpayer’s
estimates or assumptions that have no supporting records.”
(CCA 199921045) Additionally, if cost segregation is done
too aggressively, taxpayers are subject to a 20% penalty
on the portion of any tax underpayment due to a “substantial
valuation overstatement.” (IRC section 6662(a)) (If
the valuation is overstated by 200% or more than the correct
amount, an overstatement has occurred.)
If there is no third party report, accountants are in a precarious
position: they must either err well on the side of caution
and understate a taxpayer’s chattel; put him or herself
and the taxpayer at risk by estimating; or not depreciate
chattel at all. But if there is an independent, documented,
third party report, both the accountant and taxpayer can
confidently deduct the most the IRS allows.
IRS regulations are intricate and any accountant would be
hard-pressed to be on top of all the regulations. Most accountants
do not have the time or expertise to produce a complete
appraisal at an economical price. Boost the efficiency of
your advisors and add Chattel Professionals to your team.
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| Why haven’t I heard of this
before? |
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There are a few reasons why cost segregation reports
are only recently becoming widespread.
Time since the tax code change:
In 1986, Congress eliminated the Investment Tax
Credit and increased the depreciation time for buildings.
Since this decreased deductions for taxpayers, accounting
firms thought of separating out the components of
buildings that had shorter depreciable lives. In
the beginning, because of the lack of protocol and
expense of the reports and their defense, cost segregation
was feasible only for very large holdings.
IRS buy-in: In the early
stages, the IRS did not agree with cost segregation
and contested it in many court cases. The turning
point was the case in 1997-99 against Hospital Corporation
of America, which the IRS lost. Shortly after that,
the IRS issued Chief Counsel Advice 199921045 and
laid the officially recognized groundwork for cost
segregation.*
Now, the government recognizes cost segregation as a legitimate
strategy to encourage business development. Here are two
IRS publications regarding cost segregation:
Lack of professional expertise and public knowledge:
It usually takes time for new information to be
disseminated. For example, it took many years before
1031 exchanges became readily accepted and available.
It takes time for protocols to be established and
challenged, and for enough professionals to get
educated. Additionally, it was only very recently
that we have been able to efficiently offer chattel
valuations, making it affordable for properties
with a cost of as low as $50,000. In the past, the
report itself could cost more than that.
| *Under Code 167(a), the IRS allows a reasonable
allowance for a deduction, over time, for the cost
of capital or income earning assets. Code Sections
38 & 168 and Revenue Procedure 87-56 later clarified
by Revenue Procedure 88-22, provide guidance on the
life of a given object that is depreciable. |
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Why should I use Chattel Professionals?
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We save you time and money! Our tax-deductible service gives
you an impressive return on investment, and immediate, measurable
tax savings.
Our mission is to help you keep more money in the most efficient
way possible. We are committed to providing value to investment
real estate owners. We do this with individual attention,
excellent customer service and economical reports done with
IRS-approved methodology. We use trained appraisers, top-notch
CPAs and real estate professionals. Our costing techniques
and protocol are approved by the IRS, and our valuation
partner has been in business over 70 years.
Chattel Professionals employs a two-step methodology. Costs
of the components – inclusive of labor, material and
installation, as well as the component conditions –
are first accumulated. These costs are then further refined
by empirical data. As required by the IRS, valuation of
building components is based on a “logical and objective
measure.” Chattel Professionals provides that objectivity
using high-quality studied data provided by our valuation
partner. This ensures that the conclusions reached in the
summary are reliable and based on the data entered.
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A cost segregation report will not save
me any money.
I don’t have any assets that qualify as chattel.
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Even an empty residential unit has over 50 items that can
be classified as chattel. Estimating conservatively, an
average 1,500 square foot home contains approximately $15,000-$20,000
worth of chattel. That translates to a $3,000-$4,000 reduction
in taxable income in just the first year. If you are in
a 25% tax bracket, that means you keep an extra $750-$1,000
in the first year. The savings continue for an additional
five years. If the property is newer, the value of chattel
is often much higher, and if your tax bracket is higher,
the savings are higher.
This also does not take any state tax savings into account. |
Will this trigger an audit?
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The IRS encourages the use of chattel valuations and cost
segregation – the reports produce more accurate accounting,
and the savings stimulate business. In 1999, the IRS issued
a Legal Memorandum stating that reclassification of assets
for shorter life depreciation would not be contested by
the URS (ILM 199921045. TNT 104-65 April 1, 1999). The Memorandum
also advises field agents to confirm that the classifications
are based on a study produced by experts. |
Can’t I do this myself?
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Yes, you can. But you probably will not want to. It is a
question of expertise, methodology, accuracy, peace of mind
and what you feel your time is worth. You can also do your
own taxes but, unless that is your area of expertise, is
that the wisest choice?
Additionally, the IRS prefers that valuations and reports be performed
by independent, third party, and they state that an “accurate
cost segregation study may not be based on non-contemporaneous
records, reconstructed date or taxpayer’s estimates
or assumptions that have no supporting records.” (CCA
199921045) In Chapter Four of the IRS Cost Segregation
Audit Techniques Guide, the first listed element of
a quality cost segregation study is preparation by an individual
with expertise and experience.” Even using third party
software but compiling the data and the report yourself
poses the same risks plus a learning curve and your time.
Consider what is at stake if you don’t get it right:
You may risk exposure to an audit; you might understate
your values and lose money (the IRS has very specific regulations
about costing components); you might overstate your values
and risk penalties. Moreover, the fee for our economical
service is tax-deductible, and you will recover more than
the fee in the first year. |
How much loss am I allowed to claim?
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If your modified adjusted gross income is $100,000 or less, the IRS allows a maximum
of $25,000 in passive losses per year. If your modified adjusted gross income is
$150,000 plus, you cannot deduct any losses (but you can carry unused losses forward). Between $100,000-$150,000, deductions are reduced by 50 cents for each dollar that the modified adjusted gross income exceeds $100,000 (e.g., if your income was $125,000, your maximum allowable deductions would be $12,500).
“Passive” relates to your occupation and it
means that you do not spend the majority of your time actively
engaged in the business of real estate; that you invest in real estate as a side occupation. "Active" means your primary business activity - anything in which you are actively engaged.
There are passive gains and passive losses, active gains and active losses. Examples of gains are income and profits; examples of losses are depreciation and business operating expenses. If you are not a real estate professional, you can deduct up to $25,000 in passive losses per year, as stated above.
If your deductions total more than $25,000, you
can carry those losses forward indefinitely and use them
as deductions (losses) against your gains
in following tax years (the $25,000 maximum applies each year). For example, you could use them to offset capital gains when you sell a rental property; or if your modified adjusted gross income fell below $150,000 in a given year.
However, if you are a real estate
professional (what the IRS terms as “active”),
there is no maximum on the losses you can claim.
You can use unlimited depreciation to offset active gains. This is a significant benefit. You or your spouse may be able to claim real estate professional status. Please contact your CPA or tax attorney for your individual situation.
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Can I carry my losses forward?
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Yes. Any real or paper losses that you cannot use in a tax
year can be used in following tax years. |
What determines if I am a real estate
professional?
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How much time you spend on real estate activities determines
the status. There is no firm test but rather a few factors.
You do not have to meet all conditions:
- Do you spend the majority of your time on real estate
activities?
- Do you spend a minimum of 750 hours on real
estate activities? This is approximately 15
hours per week and includes everything you do
related to real estate; even supervising people
you hire to perform services. 500 of the 750
hours must be “active” hours –
hands-on work. Document your hours by keeping
an informal notebook.
Here
are definitions of true real estate activities
- Do you own 5% or more of an entity that engages in
real estate activity? And are you an employee of this
company?
- Do you have a real estate salesperson or broker license?
(If you don’t, this does not mean that you cannot
be a real estate professional.)
- Do you own at least 21 rental units? You can be considered
a dealer or real estate professional if you own at least
21 rental units.
Please contact your CPA or tax attorney for your individual
situation. |
What if I plan to turn my primary
residence into a rental unit or vice versa? Is a chattel
appraisal still beneficial?
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Please contact your CPA or tax attorney for your individual
situation. |
How do you calculate Return
on Investment (ROI)?
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“I’d gladly pay you Tuesday for a hamburger
today.”
-Popeye's sidekick, J. Wellington Wimpy
When considering investments, we calculate ROI to determine
and compare profitability, or benefits versus costs. The
calculation produces a number – a performance measure
– so you can judge the profitability. So what is the
Tuesday payoff that Wimpy offers?
| ROI = |
Wimpy’s payback
to you – The money you paid for the
hamburger
The money you paid for the hamburger
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If you pay $2.75 for Wimpy to have a hamburger today, and
he agrees to pay you $4.00 on Tuesday, here is the performance
measure:
| ROI = |
$4.00 - $2.75
$2.75
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= 45% |
That is the simplest way to calculate ROI. See the sample
ROIs on a chattel appraisal in our Case
Studies or call us to talk about an estimate on your
situation – 888-844-1390.
ROI calculations are easily manipulated and can
be more complicated. You can determine to include
or exclude many other elements for your costs and
returns – a time factor, income, carrying
costs, for example. Here is an online calculator
that includes many factors for figuring ROI on a
real estate investment: http://www.fincalc.com/inv_04.asp?id=6 |
Can I claim depreciation
I missed taking in prior years ("catch-up" depreciation)?
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Yes. For tax years 2003 on, taxpayers are allowed to apply
a cost segregation study to a prior year without IRS consent.
If a taxpayer has filed only one tax return for a specific
property, filing IRS Form 3115 (“Application for Change
in Accounting Method”) provides an “automatic
change” in the depreciation schedule; taxpayers can
claim refigured depreciation without filing an amended return.
The IRS has reported that filing a Form 3115 is not a red
flag for an audit.
Instructions for Form 3115:
http://www.irs.gov/instructions/i3115/ch01.html
Form 3115:
http://www.irs.gov/pub/irs-pdf/f3115.pdf
If you have filed 2 years or more of returns on your property,
you or your accountant must file Form 3115 and then a Section
481 Adjustment. Please contact your CPA or tax attorney
for your individual situation. |
What about recapture tax? Doesn’t
increasing my depreciation just mean that I will
be shifting taxes from now until I sell the property?
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Recapture tax is applied when you sell appreciated
property on which you have taken deductions for
depreciation. The portion of the gain equal to the
total amount of depreciation will be taxed at your
ordinary tax rate but can be no more than 25%.
That means that, even if you are at the 35% tax
bracket, you can only be asked to pay 25% recapture
tax. If you are in the 15% tax bracket, you will
pay a recapture tax rate of 15%.
And - this is important to note - if you
exchange the property in a 1031 tax-deferred exchange,
you do not pay recapture tax. As long as you sell
and buy using a 1031 exchange, you can defer taxes.
If you choose to leave the property to your heirs,
that tax is never paid because your heirs
receive the property with a "stepped up" basis (in
other words, your heir's basis in the property is
the market value on the day you die, and they owe
no recapture tax).
But is recapture tax so bad? No. If you decide to sell a property without a 1031 exchange, you will owe the recapture tax but you will have had the use of the money. It's as if the IRS has loaned you money interest free. Additionally, depending on your tax bracket you may end up paying less back than you received. For example, if you are in the 40% tax bracket and only pay back at the 25% (the highest rate possible), you get to keep the difference.
Please contact your CPA or tax attorney for your individual situation.
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Doesn’t increasing my depreciation
just mean that I will be shifting taxes from now until I
sell the property?
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No and yes. Please see the Recapture
Tax FAQ. No, if you choose to sell your property and
buy another one using a 1031 exchange. Yes, if you do not
do that. But you will still have had many years use of present
value money that you will only have to pay back a portion
of at future value rates. Additionally, you will have lowered
your…
Please contact your CPA or tax attorney for your individual
situation. |
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