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Houston Tax Reduction (Casualties Can Generate Substantial Tax Reduction) Tax reduction are the results from tax deductions. (Tax credits are another option for reducing federal income taxes. However, there are currently few options available to generate tax credits.) Tax deductions reduce taxable income but do not directly reduce federal income taxes. Federal tax laws provide special provisions that generally provide real estate investors a lower level of federal income taxes than investors in other types of assets. For example, $100,000 of tax deductions reduces federal income taxes by $35,000 ($100,000 X 35%), assuming a 35% tax rate. Most tax reduction require a cash expenditure (labor, material, supplies, utilities, etc). A current period cash expenditure is not required for some real estate tax deductions and may not be required for a casualty loss. A casualty loss can occur as a result of any sudden, unexpected and unusual event. A casualty loss could occur as a result of a shooting spree such as the shooting spree that occurred at Trolley Square in 2007 in Salt Lake City Utah. A casualty loss may occur as a result of a flood, hurricane, tornado, mudslide, or other natural disaster. A casualty loss can generate a massive level of additional depreciation. The intuitive thought pattern is: My apartment complex worth $5,000,000 suffered major damage totaling $1,500,000 for repairs and rent loss. Fortunately, I was completely covered for both physical damage and rent loss, other than a small deductible. There is clearly no casualty loss which will generate tax reduction, right? Most real estate owners and investors believe the above statement to be true. Few investors claim the casualty loss tax reduction the federal income tax code allows them. After a casualty loss, property owners should consult both a real estate appraiser and a tax return preparer regarding the options for claiming a casualty loss on their tax return. Let's next review the criteria for a casualty loss tax deduction and the thought process regarding acquisition of a property that has suffered a casualty. Real estate owners suffer a casualty loss when the market value immediately after the casualty plus insurance proceeds is less than the market value immediately before the casualty. The complex issue is how to value the property immediately after the casualty. Factors that cause a loss in value extend well beyond the cost of repairing the physical damage. In some cases, the cost of repairing physical damage is inconsequential in contrast to other factors that have a deleterious effect on value. Let's consider a 1-story suburban office park in Mississippi which suffered 3-feet of flooding due to Hurricane Katrina. Let's further assume: 1) 8 feet of sheet rock must be replaced in the entire property to rebuild, 2) although the property was 90% occupied before the flood, occupancy is expected to only be 5% while rebuilding occurs, 3) stabilized occupancy after renovation is not clear since some businesses may not return, 4) construction will take 12-18 months due to the labor constraints and 5) the owner has casualty insurance to rebuild but did not have rent loss/business interruption insurance. It is clear the market value after the casualty is less than the market value before the casualty less construction costs. Other factors to consider are: rent loss, market risk that not enough tenants will be available after construction is completed, cost of construction management, a illiquid market with few buyers just after the casualty, construction risk, interest rate risk (rates could rise during the construction period negatively affecting value), risk that operating expenses could increase during the construction period (perhaps insurance) and compensation for entrepreneurial effort to induce a buyer to coordinate labor capital, management and endure the previously mentioned risks. Real estate appraisers have the experience and training to be able to objectively evaluate these factors and develop an opinion of market value prior to the casualty and immediately following the casualty. A careful analysis by an appraiser might show the improvements have no value after the flood. In other cases, the residual damage (in addition to the cost to repair physical damage) might not be substantial. In appraisal assignments performed by the writer, a casualty loss of 10-30% of the market value before the casualty has occurred (in a straight-forward, defensible analysis) is typical. This can generate a meaningful casualty loss tax deduction which results in tax reduction. For example, a property with a market value of $5,000,000 suffers a 30% casualty loss. While the casualty is a serious hardship for the owners, the $1,500,000 ($5,000,000 X 30%) tax deduction will mitigate the financial loss. Based upon a 35% tax rate, the tax reduction is $525,000. Congress provided a casualty loss tax deduction to encourage investment in real estate. If you have the misfortune to suffer a casualty loss, take the helping hand offered by congress and take the tax deduction. Click here for a FREE preliminary analysis of income tax savings for your property. Cost segregation produces tax deductions and reduces federal income taxes across the country and in every size market. Below are just a few examples of cities where cost segregation generates meaningful tax deductions. City:
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