Tom's Blog

My friend, Dave Sullivan, asks the following question about "component" depreciation:

I was wondering if rental real estate held in an LLC can use component depreciation for accelerated paper losses, and a resulting higher monthly cash on cash return? I read component depreciation could be used in Robert Kiyosaki's real estate book, but then saw this online:

"Component depreciation
At the end of a seminar to a religious group, he says he (Robert Kiyosaki) recently did a real estate deal where he got a 17% cash-on-cash return and that "there's 24% component depreciation on the property." Really? Gee, and I thought component depreciation was explicitly outlawed by the Economic Recovery Tax Act of 1981. Actually, I'm sure of it. It's right there in Section 168(f)(2) of the Internal Revenue Code."

A: I'm not sure where Dave read this comment about component depreciation, but the person making the comment is simply misunderstanding the difference between component depreciation and cost segregation. While it is true that "component" depreciation was eliminated with ERTA (the 1981 tax act), we can still do what we now call "cost segregation." After the 1986 Act, the IRS initially believed that cost segregations were still outlawed. However, this position by the IRS was overturned by the courts, notably in the Health Corporation of America (HCA) case in 1993. With this case, the IRS finally gave in and formally announced that it would allow cost segregations for property placed in service after 1986. There is even an IRS audit guide that specifies how a cost segregation must be done in order to be allowed by the IRS.

A cost segregation, while technically not component depreciation, has the same effect as component depreciation, just under the "new" (i.e., post-ERTA) depreciation tables. This means that we can segregate the costs of the building, the building fixtures (e.g., cabinets, ceiling fans, window coverings), and land improvements and depreciate them under the appropriate rates for those types of items. Typically, a cost segregation will result in much more depreciation in the early years of building ownership which can put a lot more money in the pockets of the owners through lower taxes.

At ProVision, we recently developed a home-study course about how to maximize your depreciation deductions. Look for it's release in the coming weeks at http://www.provisionwealth.com/products.

So when you are buying a building, consider performing a cost segregation following the IRS guidelines. IRS guidelines require an outside professional, such as ProVision, to do the cost segregation. Contact us at 866.467.5809 or cs@provisionwealth.com for more information on how we can help you maximize your depreciation deductions.

Warmest regards,

Tom

For those of you keeping track, last weekend was my triathlon in Rocky Point, Mexico. My goal was to improve my time by 30 minutes. A pretty aggressive goal. Most of this was to come from the run portion. My good news to report is that I did trim substantial time off my run (about 20 minutes), despite my lack of run training. While not meeting my goal, it went a long way towards my goal and I hope to get the additional 10 minutes off my run by my next triathlon. I attribute most of my run success to the socks that I got from http://myfootguy.com. These are amazing socks that provide tremendous ankle and foot support. My gimpy ankle was just fine after the 10k run. Amazing!

The bad news is that my swim and bike were slow this time. I'm not sure why, but I am sure that I need to pick up my training and I need to get a coach. I believe a coach will not only help me set goals and be accountable, but will give me advice on how to better train and how to race better.

I think I was a little worried that I might run out of gas on the run if I pushed the swim or the bike too hard. This goes to the mental part of racing. I simply don't know enough about my body and what to expect (how I should be feeling during each part of the race). A coach would be extremely helpful in this regard and I found one while mingling with the other triathletes in Rocky Point.

Of course, wealth building is very similar to triathlon training. We have to set goals, be accountable, and continue to focus on what we are trying to accomplish. We also need a coach. You have heard me say it before, but I'm saying it again anyway. A wealth coach should help you with the mental aspects of wealth as well as giving you advice, providing accountability, and helping you set goals.

I am pretty anxious to get started with my triathlon coach. I suggest you get started with your wealth coach. Find out more about wealth coaching on the ProVision website at http://www.provisionwealth.com/wealthstrategies.asp.

Warmest regards,

Tom

Alphonso asks the following question: Hi Tom, thanks for keep in touch with me. Your Information is so valuable and very welcome. At this time, I have some questions about income. How can I split my income as a 1099? I understand we need to manage and organize every penny, so I am splitting in this way: 10% Tith 15% Tax Savings 15% Advertising 30% Personal Income 30% Business Expenses Any suggestion? My other question is about my wife. She is W2. How you suggest to split her income? Thanks

A: I'm not exactly sure what Alphonso is asking, but let me suggest there could be two different questions here. The first is the best allocation of income to various expenses. I think that is a question for your Wealth Strategist. At ProVision, we believe that each investor should develop their own personal wealth strategy that is unique for them. Visit http://www.provisionwealth.com/wealthstrategies.asp for more information or see our wonderful Wealth Strategy home study course, Financial Freedom Now! at http://www.provisionwealth.com/products.

The other possible answer to the question has a tax angle to it. Could a person split their 1099 income between multiple companies to lower tax brackets? The answer very well could be "yes." If different companies perform different tasks for a client, then the client could pay each company for that service rendered. This could be especially beneficial if one of the companies were a "C" corporation. C corporations have their own tax brackets and the first $50,000 is ordinarily taxed at a 15% tax rate. Look for more on this strategy when we release our home study course on using C corporations. It will be released in the next few months, so be sure to keep a look out for it. We recently included it with the package we released to the Rich Dad Forum participants and it was very well received.

Remember that permanent tax savings, such as lowering tax brackets, are one of the key secrets to a successful tax strategy.

Warmest regards,

Tom

Thanks to David for giving the following feedback to our recent email entitled, "The HUGE difference between tax and legal terms and how it impacts your tax strategy."

Good point Tom.

Even though we have to consider taxes, and asset protection together, we also need to remember it's a joint effort by the CPA, and Attorney. It's good that a CPA find the best tax advantages, and consult with the Attorney for the best asset protection for the individual situation. A CPA that keeps an eye on the big picture is a bonus, but one that ignores tax advantages because of well known legal advice is a drawback.

After reading the part "I find that those who have the most successful tax strategies are those who understand the basics thoroughly. And by that I mean they know enough to know when to ask questions and seek expert advice. " I agree totally. Will I have access to the "Fundamentals in the Entity Formation section of Tax Mastery in Wealth Strategy U"

A: There is a tremendous amount of free information in Wealth Strategy U under the Tax Mastery section. Just log in at http://www.provisionwealth.com/wealthu. For even more information about entity formation, you might want to try our recently released home study course entitled, "How to Create Your Own Tax Savings By Building the Perfect Tax Structure: 5 Strategies to Selecting Entities that Reduce Your Taxes." You can get this through our website at http://www.provisionwealth.com/products.

Warmest regards,

Tom

Craig asks a very interesting question about his automobile expenses:

Q: Presently I am taking the standard cents per mile deduction on my vehicle under my current occupation. Due to the AMT, my accountant tells me I net back only about 2% of ALL of my expenses. How can I use my C-corp or LLC more for these expenses.

A: The issue here is that if you are an employee and you have unreimbursed expenses, such as automobile, travel, meals or other, they are only deductible as miscellaneous itemized deductions (MID) on your Schedule A. The problem with this is twofold. First, they are subject to a 2% floor, i.e., you only get to deduct MID to the extent they EXCEED 2% of your adjusted gross income (AGI). Second, they are not deductible at all for AMT purposes.

The solution is to incur these expenses as a business, not as an employee. Let's say, for example, that you are in sales. Your company allows you to either be an employee or an independent contractor. As an employee, you lose the deductions. But as an independent contractor, all of a sudden these expenses become fully deductible, not subject to either the 2% or the AMT limitations.

Of course, there are other issues with becoming an independent contractor that you need to consider, including loss of benefits and Social Security taxes.

Just paying these expenses out of an LLC or corporation will not solve the problem, so long as you remain an employee. The reason is that they expenses relate to your employment and not to your LLC or corporation. You can only deduct expenses in your LLC or corporation that belong to that entity. Paying someone else's (in this case, your) expenses is not allowed as a deduction by the IRS.

Contact your ProVision Tax Coach for tax strategies to take advantage of the independent contractor status. There are ways to minimize the Social Security taxes and even the loss of benefits.

Warmest regards,

Tom

Craig asks another question, this time about paying expenses out of a sister company or personal account.

Q's about the do's and don'ts during business set-up of using personal credit cards-then writing a check from the business to pay us back. As long as we write a check from "personal acct" back to the business to cover the "non-business" expendatures is that OK? OK to use our airmiles, personal cc for business purchases and then reimburse ourselves with company check? What is the proper way to loan your new LLC/C-corp money from your personal accounts and then get reimbursed months down the road with interest?

A: First, it's always okay to pay business expenses with a personal credit card and then get reimbursed later from the company. You should prepare an expense report just like you would if you were employed by an unrelated company like IBM. You do have to meet certain rules, as you must have an accountable plan. Talk to your ProVision Tax Coach about this.

It's not okay, however, to pay personal expenses from your company account. The problem is that the IRS looks at this as an abuse and may argue that your company should not be respected as an independent entity. Instead, you should distribute funds to yourself, either as salary or a distribution, and then pay your expenses from your personal account. Remember, that you must always treat your company as a real business, not as a personal bank account. So pay your personal credit card from your personal account and seek reimbursement from the company, not the other way around.

As for the loan to the company, I suggest you do a formal loan agreement between you and the company, specifying an appropriate interest rate and payments terms. The interest rate must be no less than the Applicable Federal Rate for that loan. Contact your ProVision Tax Coach at tc.tempe@provisionwealth.com for more information about the structuring of the loan and the interest rate for the loan.

Warmest regards,

Tom