Real estate as as investment class, in general, comes with certain tax benefits that are found nowhere else, but some would say that mobile home investing is the best of the best when it comes to tax favored status with the IRS. The not-so-secret word we are concerned with today is “depreciation,” a poorly understood and often underused strategy to reduce your Federal tax burden. When you are able to depreciate part of an asset, that number directly reduces the amount of income you must state on your tax return which, in turn, also directly reduces the amount of income tax you’re required to pay.
Tax law allows residential real estate to be depreciated over the course of 27.5 years, except for commercial property, which must be depreciated over 39 years. This is where too many rental property owners’ knowledge stops and causes them to miss big chunks of expenses that could be depreciated over a shorter term, usually 15 years, by being categorized as land improvements or operating expenses.
Items that can add up to a considerable expense, like roads, water lines, sewer lines, and electric poles are not a capital expense but rather a land improvement. Nothing sneaky about it. The IRS allows land improvement expenses to be depreciated over the shorter term of 15 years rather than the traditional 39 often associated with mobile home investing. Let’s say you spent $50,000 on land improvements. Credited over the course of 39 years yields a depreciation of $1,283 a year. Take the same amount and depreciate it over 15 years and you have a much more impressive annual deduction of $3,333.
A good tax consultant can also help a mobile home park owner properly categorize expenses as either capital expenditures or operating expenses. Think of an operating expense as something that does not extend the life of the asset but helps to maintain it in operational condition. For example, say a motel owner discovers that 20% of his building has a problem with rotten wood that threatens structural stability. Unless he wants to lose the business entirely to a collapse, he needs to replace the rotten wood and repaint the entire motel to match again. This expense did not extend the life of the motel. It only returned it to the condition necessary to keep it operational.
As you might guess, these differentiations can be quite technical in nature, thus the necessity of having a taxt professional look over your general ledger and help with the categorization of expenses. This might seem like unnecessary expense and effort but, trust us, it can worth the effort in tax savings. Some estimates say the proper categorization of expenses can increase depreciation claims by 50% to 100% during the first five years of ownership.
The MHP Listings Team
Flickr / IRS EIN