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Youre getting an income tax refund! Those are the words that every taxpayer would love to hear. A federal income tax refund occurs if the tax you owe is less than the sum of the total amount of refundable tax credits claimed and the total amount of withholding paid. For many individual taxpayers those federal tax refunds can be obtained through Earned Income credit, a real refund of overpayment of tax, or through an overpayment from previous years. Some people really believe that getting a large income tax refund is not the greatest thing. Instead they feel that the tax refund represents a loan paid back by the government interest free. Others use their IRS tax refund as a simple savings plan where they are surprised to get money back each year. Always remember that it is still better to get an IRS tax refund than to owe money to the government.

Once you determine youre receiving a tax refund, there are several options for actually putting that money in the taxpayers hands. Standard paper filing, electronic filing with direct deposit, rapid refunds, and refund anticipation loans are the options we have the choice of exercising, and for many refund anticipating individuals, the rapid refund or the refund anticipation loan is the refund of choice.

Since the advent of the computer age, and the great invention of the internet, the Internal Revenue Service (IRS) has been fairly quick to react to the benefit of electronic filing. The income tax returns are filed much faster, tax refunds are made faster, and money due the IRS can be obtained faster. Lets take a minute to look at the different IRS refund options, and what each offers the individual taxpayer.

The standard paper filing, although many are more familiar with this method of filing, is slowing reaching obsolescence. There will soon come a time that the old system of paper tax filing will be entirely eliminated and replaced by the electronic tax filing methods. If you are still one of the dying numbers of Americans who files a paper tax return, you should anticipate receiving a tax refund in about six weeks; today, thanks to the great use of the internet, six weeks to receive a tax refund, seems like an extremely long time.

The rapid tax refund, that is rapidly replacing the standard paper filing, is an electronic method used for filing your federal income tax return, and allowing you to receive your refund in about 10-14 days. Much faster than the six weeks it used to take. There are usually no excess fees attached to this type of filing, and returns may be filed for free through many local, public access facilities.

The refund anticipation loan, however, is a little different. These must be administered by a tax professional through an established alliance with a financial and lending institution. There are several excellent choices available, and many qualified tax professionals to complete your tax return, you will however be required to pay a loan fee or a small interest fee for the opportunity to obtain an refund anticipation loan. There are several restrictions placed on receiving a refund anticipation loan, and some of the restrictions may affect many people. For example, if you owe back taxes, back child support, or liens and judgments, you cant qualify for the refund anticipation loan. Most often, the individuals who apply for and use the refund anticipation loan are recipients of earned income credit, and their tax refunds are usually well into the thousands of dollars. The refund anticipation loan can be processed in as little as three hours, and back in the hand of the taxpayer by late afternoon; this is provided everything works exactly as planned. The higher interest rates charged by the bank product providers, and the higher processing fees charged by the tax preparers, equate to less money for the taxpayer, but many of these individuals dont even blink when told how much it will be to process their federal tax return, they just want the refund immediately. This is just one more example of the instant gratification upon which our society chooses to operate. Even for individuals filing with the electronic returns, and choosing to have their funds direct deposited, the turn around time is usually no more than 10 to 15 days. You would think that a turn around of less than two weeks would be quick enough for many taxpayers, but typically, the bigger the federal income tax refund, the faster the necessary return.

It would seem to me that this is just another way for the system to profit from the poor; as it is usually the poor that qualify for the earned income credit tax refunds, and these can be extremely large, especially for families with two or three dependents. In all reality, avoid refund loans if possible. They are highly expensive. Wait patiently for your federal income tax refund and keep every penny for yourself.

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Hit a big one? With more and more gambling establishments, keep in mind the IRS requires people to report all gambling winnings as income on their tax return.

Gambling income includes, but is not limited to, winnings from lotteries, raffles, horse and dog races and casinos. Unfortunately, gambling income also includes the fair market value of prizes such as cars, houses, trips or other non-cash prizes.

Generally, if you receive $600 ($1,200 from bingo and slot machines and $1,500 from keno) or more in gambling winnings and your winnings are at least 300 times the amount of the wager, the payer is required to issue you a Form W-2G. If you have won more than $5,000, the payer may be required to withhold 25 percent of the proceeds for Federal income tax. However, if you did not provide your Social Security number to the payer, the amount withheld will be 28 percent.

The full amount of your gambling winnings for the year must be reported on line 21, Form 1040. If you itemize deductions, you can deduct your gambling losses for the year on line 27, Schedule A (Form 1040). You cannot deduct gambling losses that are more than your winnings.

It is important to keep an accurate diary or similar record of your gambling winnings and losses. To deduct your losses, you must be able to provide receipts, tickets, statements or other records that show the amount of both your winnings and losses.

Face it, the IRS gets you coming and going. Well, Im off to play poker.

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This is the first of a series of 2007 Tax reference sheets that I’ll be sharing with you over the next month or so. This one focuses on some of the major federal income tax key numbers. I’ll do future ones for estate planning, retirement planning and business planning in the not too distant future so stay tuned.

Since federal income taxes are such a large part of most peoples life or expenditures, I thought that you might like a summary or reference sheet for some of the important figures for 2007.

Many people believe that if someone is in the 28% tax bracket, they pay all taxes due at the rate of 28% of taxable income. This is not correct. A couple having a taxable income of $125,000 does not pay 25% federal income tax on ALL of the taxable income… but only on everything over $63,700. The first $15,650 is only taxed at 10%, the taxable income from $15,560-$63,700 would be taxed at 15% and so on. The figures below is taxable income (after deductions and exemptions).

I’ll start out with the tax brackets for the 2007 tax year.
The figures below show the various “steps” on how the
marginal income brackets are progressively taxed higher.

Married, Filing Jointly:

$zero – $15,650 is taxed at 10%
$15,650 – $63,700 is taxed at 15%
$63,700 – $128,500 is taxed at 25%
$128,500 – $195,850 is taxed at 28%
$195,850 – $349,700 is taxed at 33%
over $349,700 is taxed at 35%

Married, Filing Separately:

Note: Often times it make more sense for a married couple to file taxes separately for either tax reduction strategies or for non-tax reasons. Your tax advisor should help you decide if there are important reasons for YOU to take advantage of this filing status.

Tax brackets for Married Filing Separately: Simply cut the above taxable figures in half for those six tax brackets

Single:

$zero – $7,825 is taxed at 10%
$7,825 – $31,850 is taxed at 15%
$31,850 – $77,100 is taxed at 25%
$77,100 – $160,850 is taxed at 28%
$160,850 – $349,700 is taxed at 33%
over $349,700 is taxed at 35%

Single, Head of Household:

$zero – $11,200 is taxed at 10%
$11,200 – $42,650 is taxed at 15%
$42,650 – $110,100 is taxed at 25%
$110,100 – $178,350 is taxed at 28%
$178,350 – $349,700 is taxed at 33%
over $349,700 is taxed at 35%

Standard Deduction:

Standard Deduction is ONLY for those who do NOT itemize expenses like mortgage interest, charitable contributions, etc.

Married, Filing Jointly: $10,700
Married, Filing Separately: $ 5,350
Single: $ 5,350
Single, Head of Household: $ 7,850

Those who are blind or over age 65 can ADD $1,050 (if married) or $1,300 (if single or head of household) to the above Standard Deductions

Personal Exemptions:

Personal Exemptions are set at $3,400 per allowed person subject to Phaseouts (which are reductions in the Exemptions) based on taxable income. This is not an issue unless your taxable income is at least $117,300 (depending on filing status).

Maximum taxable EARNED income subject to FICA tax: $97,500

The Social Security and Medicare combined tax rate is 15.3% on income up to that figure. W-2 employees pay half of the 15.3% and employers pay the other half. Self-employed pay the whole amount.

Long-term Capital Gains and Qualified Dividend Rates:
For those in the 10% and 15% Income tax brackets only: 5%
For taxpayers in the higher tax backets: 15%
Capital gains on collectibles (coins, stamps, etc.) 28%

One of the important functions of a financial advisor is to help reduce taxes to your legal minimum due by using all appropriate deductions, methods and strategies. A good tax advisor is worth their weight in gold! So go find a pro-active tax advisor, not someone who just files tax returns.

And now, hopefully you will have a better idea of what that person is talking about.

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Cost Segregation : Why are 90% of real estate investors overpaying federal income tax?

By ignoring generous IRS guidelines when establishing depreciation schedules, over 90% of real estate investors are unintentionally overpaying federal income taxes. In addition they are paying federal income taxes earlier than necessary, typically years or decades earlier than necessary. Although these IRS guidelines are relatively new, they provide substantial benefits. Since this is a relatively new issue, many accountants have not integrated the new IRS depreciation guidelines into their practice. Savings for real estate investors are meaningful- exceeding $50,000 to $1,000,000 in the first year. Cost segregation converts income taxed at 35% (ordinary income) to income taxed at 15% (capital gains). Cost segregation also defers payment of income taxes, often for 5 to 10 years.

Effects of higher depreciation

Most real estate investors do not understand the benefits of increasing real estate depreciation. They often ask, “doesn’t increasing my depreciation just mean that I will be shifting taxes from now until when I sell the property?”

This is a popular misconception and the answer is a resounding “no”. There are two benefits of increasing depreciation:

1.Converting ordinary income into capital gains income
2.Deferring income until a gain on the sale of the property is realized.

The conversion of ordinary income into capital gains income has to do with the technical nature of the allocation of the gain on the sale. Many, if not most, accountants initially believe it is simply a timing issue. However, when the mechanics of recognizing gain on sale are discussed, accountants quickly realize increasing depreciation leads to paying taxes at the capital gains rate as opposed to the ordinary income rate.

Correcting a depreciation schedule makes a difference if you recently sold a property since the additional depreciation will be taxed at the capital gains rate instead of the ordinary income rate. For example, assume an investor sold a property in late 2005, does a cost segregation study, and increases depreciation by $100,000. The net result is the ordinary income taxes will be reduced by $35,000 ($100,000 x 35%) and the capital gains taxes will be increased by $15,000 ($100,000 x 15%). This nets the owner $20,000 in federal tax savings by simply correcting an error in the depreciation schedule after the property has already been sold.

When told it is possible to increase depreciation and reduce federal taxes, most real estate investors ask, “doesn’t my accountant take care of this for me?”

Our experience, after reviewing thousands of depreciation schedules for real estate, is that less than 5% of depreciation schedules have been properly established. Most real estate investors have a good relationship with their accountant and believe, as a matter of faith, that their accountant is doing everything possible to minimize their taxes. Unfortunately, many accountants have not focused time or attention on this issue for several reasons. Some accountants are aware of cost segregation as an option to increase depreciation and reduce federal taxes but believe it is very expensive (at least $10,000 per property) and is financially feasible only for large properties (typically over $10 million). Many of the providers started out either as big four firms or big four spin-offs who charged between $10,000 and $50,000 per property. Many of these providers were not interested in properties with a cost basis under $10 million and only did cost segregation for newly built properties. Other accountants have not focused on the topic.

Cost segregation clearly makes sense for properties with an improvement basis of at least $500,000. In many cases it makes sense for smaller properties. While accountants are becoming more and more active in reviewing options for depreciating real estate, in many cases the owner needs to take the lead role in proposing cost segregation as a mechanism to reduce and defer federal taxes.

Property owner involvement

Many property investors proudly take the stance that, “my federal tax return is too complicated; my accountant handles it.”

It is almost a rite of passage that a “serious” real estate investor is one whose tax return must be prepared by a third party because it has become too complicated for the investor to complete. Only about 2-5% of depreciation schedule in federal tax returns have short life property properly separated to minimize the owner’s federal taxes. While many parts of the federal tax return may be too complicated for an investor to understand and prepare, this area is simple: if you pay federal taxes and can use additional depreciation, you benefit from obtaining cost segregation studies. Most investors are not aware of cost segregation and do not understand the benefits it provides. Those who are familiar with cost segregation think it only makes sense for large properties (over $10 million). Regrettably, there is limited and inaccurate information regarding a material issue that could sharply reduce federal taxes for many real estate investors.

Proportion of short life property

The proportion of short life property typically ranges from 20% to 50% of the cost basis of the improvements. Items which typically effect whether it is at the low end of the range or the high end of the range include the age, condition, intensity of landscaping, amount of surface parking, and land value.

Catch-up

What is known in cost segregation jargon as “catch-up” is reporting depreciation that has been underreported in prior years since the property was purchased or built in the current year. A real estate investor can “catch-up” underreported depreciation by having his accountant file a form 3115 with the current tax return. The IRS has reported that filing a form 3115 is not a red flag for an audit. Some investors seem concerned this is too good to be true; however, when their accountant reviews the IRS rules and guidelines they quickly find out that you can indeed catch-up underreported depreciation by filing the form 3115.
Getting started

Ask yourself the following questions when deciding whether you can benefit from a cost segregation study:

1.Do you pay federal income taxes?
2.Do you own investment real estate?
3.Can you use additional depreciation?

Some owners are passive while others are active. If you are a passive real estate investor you may not be able to use additional depreciation. On the other hand, if you are an active investor or a real estate professional, which includes people in a wide variety of activities from real estate broker to mortgage broker to leasing agent, you are entitled to deduct additional depreciation.

If you have determined you can use additional depreciation and are paying federal taxes, call a cost segregation expert and request a preliminary analysis. There should be no fee for this initial consultation. The preliminary analysis will estimate the amount of 5, 7, and 15-year property, which can likely be identified and will also identify the catch-up depreciation. This analysis will not involve a site inspection and will not be precisely correct. However, it should be accurate enough to help you decide whether a cost segregation study is financially feasible.

Once you obtain the preliminary analysis, you should consult your accountant, since he/she will be completing and signing your tax return. In many cases, it makes sense for the accountant, the property owner, and the cost segregation advisor to meet and discuss the options and issues.

Assuming you decide a cost segregation study does make sense, you should further review whether the extra depreciation should be used in a prior year, which would involve filing amended tax returns, or whether to use it in the current year. To minimize federal income taxes, make obtaining a cost segregation study a routine part of future real estate investments.

Correctly calculating real estate depreciation is important because it substantially reduces federal taxes for real estate investors. The process of fine-tuning the depreciation schedule is called cost segregation. The adoption rate for cost segregation is under 5% because of limited knowledge by many owners and accountants. In addition, there are misconceptions regarding the cost of obtaining cost segregation studies and the smallest properties for which cost segregation studies are financially feasible. As awareness of the practice and affordable service providers increase among real estate investors and accountants, the adoption rate will increase dramatically.

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