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Double Your Tax Savings by Bifurcating

A rental real estate can be a gold mine which produces four things for you: cash flow, principal reduction, tax savings and appreciation. All these four aspects can help you make a lot of money. Read through the article in order to get some detailed information about these aspects. Let us also plunge into the idea of how you can double your tax saving by simple bifurcation. Also, we answer a very frequent question regarding bifurcating taxes in this piece

The four benefits of a rental property:

  1. Cash Flow

A rental real estate can provide you with a steady cash flow. Once you have signed a rent agreement, you know for sure that the particular amount of money will be added to your bank account for a designated period. After meeting all the expenses on operating expense and mortgage, the left over finances get you going for a positive and stable cash flow.

  1. Principal Reduction

Possessing a property on rent helps you in many ways. It not only produces steady cash flow but also reduces the initial principal that was required while purchasing the real estate. It is as if the tenants are paying off your loan and buying the property for you.

  1. Tax savings and bifurcating

In order to understand how you can save money on taxes, you need to first look into the income on which you ate taxable. For this to be understood, let us assume your rental property generates $2,000 cash flow per year. Along with the cash flow, your property also helps with an annual reduction of $1,000. You need to know that both these earnings are taxable and you get an annual $3,000 benefit.
The best way to save the earned money is to head into the shelter of depreciation. The tax rules allow rental land owner to depreciate their cost over a number of years, this is also known as cost recovery. Usually, it is observed that land owners merely divvied their cost between land and building. This is a mistake and if avoided can save you tax money.
Enter bifurcation; If you split your cost among four categories: land, personal, property and land improvements, you can dodge taxes in a legal way. This is the real essence of splitting up. By bifurcating you can increase your depreciation dedication and shelter your cash flow.
Each of the bifurcation categories depreciates in different number of years according to the tax laws:

  • Land: no depreciation applied
  • Personal Property: 5 years
  • Building: 27.5 years(residential) and 39 years(commercial)
  • Land Improvements: 15 years(additions to property)

Returning to the example, let’s assume that by combining all your mentioned depreciation for the year, the total depreciation gets up to $5,000. Because of the depreciation your entire cash flow of $2,000 and principal reduction $1,000 gets sheltered. Remember, we calculated your total depreciation to be $5,000, which means that even after sheltering your initial profit you are still left with $2,000 worth of depreciation. The leftover depreciation is reported as a “loss” for income tax purposes.

  1. Appreciation

As we have discussed that there is no depreciation on land. This means that the land value will increase over the course of time. We know that a property bought a year ago is not worth the same now because of appreciation (increase in value)

FAQ: How to know about the individual costs when I start bifurcating?

These allocations can be using in many ways. Some important ones are listed below::

  • Get land and building tax ratio assessed
  • Maintain a list of building improvements
  • Have an appraiser assess your building for improvements and depreciation
  • Negotiate each of these terms on your purchase contract

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