In our last Ask Tom Live, Tax Edition, we had quite a discussion about the benefits of cost segregation. Some of our listeners had never heard of this before. So, in response to Jeffrey's question and to be clear to many others out there, here is a brief explanation of one of the best-kept secrets of the tax law - the cost segregation.

When you purchase a rental property, remember that you are purchasing not just the building and the land. You are also purchasing all of the improvements to the land, such as the landscaping, fencing, carport, and outdoor lighting. And, you are buying the contents of the building, including the wiring, cabinetry, window coverings and floor coverings.

Depreciation is the deduction available to owners of rental property for the wear and tear on the property. Land does not get a depreciation deduction, as it does not normally wear out. Buildings get a depreciation deduction of a small amount each year, as it takes a long time for a building to wear out. For commercial property, the IRS allows a deduction of the building over 39 years, or roughly 2.5% per year. For residential property, including all apartment buildings regardless of size, the deduction is over 27.5 years, or about 3.64% per year.

Land improvements are depreciated more quickly, generally over 15 year. And building contents are depreciated over 5-7 years. So, the more of the purchase price you can reasonably allocate to the land improvements and contents, the more depreciation you will get in the early years to offset your rental income (and maybe even some of your other income).

A cost segregation is a study performed by a team of CPA's and engineers to determine how much of the purchase price of your rental property should be allocated to land, building, land improvements and contents. The IRS in their audit guide for cost segregation REQUIRES that you use a CPA and/or Engineer to do the cost segregation. Of course, you must pay this professional to do the work. My experience is that in MOST cases, the fee is far less than the tax savings.

For more information about how you can get a cost segregation done on your building, contact Siggy at the ProVision offices. Her number is 866.467.5809.

Warmest regards,

Tom

We have a lot of members of our Ask Tom Live who are just starting their business or real estate investing. One of them, Joseph, asks the following question about travel expenses.

Q: If you are in the start up phase of your business can you deduct travel expenses in the current year?

A: Not until you actually start your business. If you are starting a rental real estate business, you have started when you have your first property available for rent. All of your expenses, including travel, prior to actually starting are classified as start up expenses. Once you have actually started you business, you can deduct a portion of the expenses in the year you start business and then the rest is deducted over 180 months.

For more on Start Up expenses, feel free to check out our course at http://www.wealthstrategyuproducts.com.

Warmest regards,

Tom

The most important aspect of a good tax and asset protection strategy is the entity you use for your various investments and businesses. Different investments and different businesses (and even different states) call for different entities. William, at the end of our last Ask Tom Live, tax edition, asks the following question.

Q: do i understand that you are saying that rental property should be in an LLC?

A: As a general rule, yes, LLC's work well for rental properties. In most states, they provide excellent asset protection and for tax purposes they are "flow-through" entities, meaning that the income is taxed to the owners, not to the entity. Some states have a separate tax or fee on LLC's, such as California, so it's not always the best entity. My recommendation always is to work with an experienced tax advisor to determine your tax and asset protection strategy as soon as possible.

Warmest regards,

Tom

Medical expenses are a bigger and bigger cost each year. So wouldn't it be nice if there were tax deductible? Most people understand that there is a huge floor for deducting medical expenses on your personal tax return, meaning that you have to have a lot of medical expenses before any of them are deductible. One of the best solutions to this is a medical expense reimbursement plan ("MERP") in a family business.

Under a MERP, employee medical expenses that are reimbursed by the business are deductible to the business and are NOT taxable to the employee. Most employers hesitate to use a MERP as the cost can be prohibitive. However, in those cases where all, or most of the employees are family members, a MERP can make a lot of sense.

The case law and statutes are clear that medical expenses paid for employees who are not owners are deductible in any type of entity. Medical expenses paid on behalf of owners are only deductible to C corporations. This is what gave rise to Kirby's question below:

Q: We have a family LLC. The members are my wife and our 8 adult children. I would like to know whether I would be able to setup a rather creative health benefit for my family in the LLC. (Each of them is a member with 5% or more ownership) I understand that if I provide health benefits in a regular LLC they will be taxed on this benefit as additional
income. Is this true even if the LLC chooses to be taxed as a C Corp, or would I need to create a separate C Corp in order to provide these benefits without an additional tax burden being placed on them?

The benefit I would like to create is to give full health benefits to the two children who have none and also reimburse myself and the other children for the amounts they are required to contribute to the premium of the insurance provided by their employers.

A: As long as the LLC is taxed as a C corporation, your plan should work. An LLC taxed as a C corporation is a C corporation for all tax purposes, including the medical expense reimbursement plan rules. You simply need to make sure you have a qualified MERP and that each of the children you want to be covered (since they are all adults) are legitimate employees of the company (they actually do work for the company).

Warmest regards,

Tom

The only way to truly accelerate your wealth creation is through adding velocity to your money. The two fundamentals to velocity are leverage and tax savings. Leverage can come many ways. The most obvious is through using other people's money. They key, though, is to continue borrowing so you never have much equity in you properties. Kim asks the following question in this regard:

Q: One of your strategies involve borrowing on the appreciation of real estate property to use as down payment on the next real estate property. Is this the same as a refinance on the original property (in which case cash flow would be reduced due to higher monthly payments). Or is a loan (or line of credit) that we can request from a bank...based on a new appraisal.

A: You could do it either way. The key is to have good enough cash flow from the property that as the property appreciates in value and you borrow out the appreciation, that your rents go up in proportion to your new debt service (payments). This is why we emphasize cash flow so much. The last thing you want to do is put yourself into a negative cash flow position. That's what got so many people into trouble over the last few years. Once you go into negative cash flow, by definition you have turned your asset into a liability.

Warmest regards,

Tom

This past week, I did two teleconference calls with our students. I love these calls. Next month's topic for the AskTom Live Wealth Edition is "Formal Agreements." I have been thinking a lot about formal agreements over the past few months as I have been dealing with a lot of contracts. The question that I have been fighting on each agreement is how far to go to make it "right?"

The agreements have all been with people I appreciate and respect. And people I have relationships with and hope to have relationships with for a very long time. The challenge is that what's good for a contract (and lawyers) isn't always good for business.

One of your attorney's primary jobs is to protect you, both now and into the future. So attorneys can go overboard on a contract just to protect you when what you really want is for the relationship to continue and the deal to go through. I'm fortunate that my attorney, Sandra Etherton, understands this and is willing to pull back when I ask her to.

Some of my best agreements have been through a simple handshake. That doesn't mean we don't want to put into writing many of our agreements. It just means that we need to be careful about how the legal protection might affect the relationship. Some agreements really should just be a handshake. By putting into writing what doesn't really need to be in writing, we can confuse the issues and lose sight of the real purpose of the agreement - to do business together.

Certain attorneys tend towards over protection. I call these attorneys deal breakers. Others, like Sandra, our deal makers. She still protects me while understanding that relationships are more important than legal protection.

Just a thought for today as you go about your business.

Warmest regards,

Tom