Tax season is everyone’s favorite time of the year. As you are probably aware, the IRS pushed back the filing date for individual taxpayers to May 17, 2021, which means most people will live through a longer tax season than normal. Now is a good time for veterinary practice owners to evaluate what to prioritize and consider when filing tax returns for 2020 and when planning for 2021.
Most hospital owners already do some tax planning around their practices, but relatively few focus on tax planning related to their veterinary building.
The longstanding aspects of the tax code and several relatively new developments to the tax code and the real estate market are worthy of consideration. Moreover, due to the change in presidential administrations, many tax advisers believe that changes to the tax code in years to come might limit certain tax planning approaches. President Biden has indicated a desire to revise the tax code to pay for increased government spending on infrastructure.
Now is the time to start for you and your tax adviser to discuss bonus depreciation, current capital gains rates, and like-kind exchanges. Such consideration could impact your decisions over the next 12 months.
Take Advantage of Bonus Depreciation
The Tax Cuts and Jobs Act of 2017 (TCJA), signed into law by President Trump, included provisions for the depreciating part of the value of buildings used for commercial purposes over a much shorter period than in the past. Usually, this is achieved by hiring a consultant to produce a cost segregation study of a specific building. That assigns separate useful lives and values to all of the building’s major construction assemblies or systems (components).
The IRS permits commercial real estate owners to depreciate certain building components at a faster pace than other portions. The result is that the depreciation expense in the early years of ownership of certain buildings can be increased dramatically and act as an expense shield against the property’s rental profits and cash flow.
The TCJA increased the amount of depreciation a real estate investor or owner could take in the early years, making cost segregation studies more attractive. If you recently renovated or expanded your building or bought a building, check with your tax adviser regarding the potential tax deferral to be gained through a cost segregation study.
Consider the Future of Capital Gains Tax Rates
U.S. capital gains tax rates are at historic lows, and our national deficit as a percentage of GDP is at an all-time high. Many economists and tax policy experts agree that capital gains tax rates are likely to increase over time to pay for the federal deficit and rising government spending on infrastructure and entitlements such as Social Security and Medicare. As a result, many investors who expect to realize capital gains on the sale of real estate in the next few years are choosing to consider a sale or restructuring of their holdings while capital gains rates remain low.
The perennial question of whether to pay taxes now or later might be more of a judgment call than in the past, when real estate could typically be taxed at a lower rate. At a minimum, keep future capital gains rates on your radar and consult with your tax adviser about the timing of a potential sale.
Think About a Like-Kind Exchange
The Internal Revenue Code allows owners of commercial real estate held for investment purposes to sell the property and use the proceeds to buy another investment property while avoiding capital gains taxes on the sale of the property. This rule sounds simpler than it is. Section 1031 of the Internal Revenue Code governs these exchanges, which come with various timing and structuring considerations. Moreover, Section 721 enables property owners to trade their building for shares in a REIT or ownership in a partnership.
All this can enable veterinary property owners to convert their active ownership of a veterinary building into a passive investment in a diversified pool of properties. Of course, any exchange comes with various rules and regulations, so make sure to consult with an accountant or tax adviser.
Don’t let the extended tax season end without considering your options as a veterinary real estate owner. You might be surprised that you have more alternatives than you thought.