Building or buying? How to deduct more at tax time
Careful planning can save you cash when the IRS comes knocking.
Many veterinarians own their practices and their real estate as separate entities—the practice as an S corporation, the real estate as a limited liability company (LLC). While this is a great strategy for legal protection, it can limit the deductions you claim on your taxes.
Why? In this arrangement, the IRS looks at rental activity as a passive activity, which means any loss you claim is subject to a $25,000 limit. What's more, if your adjusted gross income exceeds $150,000, you can't deduct any rent-related loss at all, at least in the year it's incurred. Instead, the amount not allowed is suspended and deducted in a year when you either have passive income or dispose of the property.
DO A COST SEGREGATION STUDY
If you're planning to acquire or build a new veterinary hospital, weigh your options carefully. First, consider a cost segregation study. These studies, performed by engineers who specialize in this type of work, allow you to accelerate the depreciation of certain components of your building. This means that instead of the entire building depreciating over the standard 39-year write-off period, certain parts depreciate over a seven- or 15-year period. The result? Rental losses well beyond the $25,000 limit. This kind of study is most cost-effective for properties costing $1 million or more.
GROUP YOUR ACTIVITIES
Next, consider grouping activities. Special rules found under IRS code section 469 let practice owners group hospital and real estate activities together, as long as all owners hold the same proportionate interest in the real estate as they do in the practice. Once you've grouped these activities, the IRS treats real estate activity as part of hospital operating activity, and rent-related loss can exceed the $25,000 limit. To take advantage of these rules, you must elect on your tax return to group activities in the year they come into existence. So if you've already created or not created your groupings, you can't regroup your activities to get a better tax break. This requires planning and good discussion with your tax advisor the year you place a new hospital building into service.
Let's say you own 100 percent of your hospital as an S corporation. You've been operating in a strip shopping center and decide to build a new $1.2 million facility, for which you commission a cost segregation study. You set up the ownership of the real estate as an LLC, and you are 100 percent owner here as well. Your first-year depreciation write-off using the cost segregation study is $105,000, and with mortgage interest and other expenses, your total rental expenses are $180,000. Your rental income is $120,000, so the loss from rental activity is $60,000. If you don't group your activities, your rental loss would likely be zero. If you elect to group your activities, you can deduct the full $60,000 loss.
As you can see, a little planning is worth a lot of tax dollars. And with taxes expected to rise, finding ways to save come April 15 can make your piggy bank very happy.
Gary Glassman, CPA, is a partner with Burzenski and Co. in East Haven, Conn., and a Veterinary Economics Editorial Advisory Board member.