The long election cycle is over and we can now start looking at the results and what it might mean for tax planning in the coming years. By now, everyone knows that the Republicans have control in the House, Senate and Executive branches of government. Knowing this, we can look at tax proposals and plan for the future based on the candidate’s plans. We can also use this information to plan not only for future years but also for the 2016 tax year.
While he was a candidate, Donald Trump pushed for lower taxes across all tax brackets, with the highest percentage of cuts coming to the highest earners. Additionally, his tax plan included a reduction of the Corporate Tax Rate from 35 percent to 15 percent. While it is still proposed, we can assume in years to come that many high earners in the U.S. will see a reduction in their tax rates.
What does this then mean for 2016? If we assume that a high tax earner may see a 7 percent reduction in tax rates, any deductions that can be accelerated into the 2016 tax year become more valuable. Under current depreciation law, depreciation deductions that have been overlooked in the past can be accelerated into the current tax year through a change in accounting method. One of the arguments against this in the past has been that this just creates a timing difference. However, if the tax policies proposed are enacted, we will have the opportunity to turn a timing difference into a permanent tax difference.
Take for example a taxpayer that acquired a property in 2006 for a cost of $3 million. We will assume that they did not complete a cost segregation study on the property at the time of acquisition. For purposes of this example, we will assume a cost segregation study would have accelerated 20 percent or $600,000 into 5 and 7 year property. Since the property is 10 years old, the taxpayer has taken approximately one quarter of the depreciation on these assets to date. This means that a retroactive cost segregation study could accelerate the remaining basis of the $600,000 into a current tax deduction on a 3115. Since a fourth of the depreciation has already been taken, this would result in a $450,000 catch up deduction.
If we assume that the taxpayer is at a 39 percent tax bracket in 2016, this will result in a tax savings of $175,500. However, if the tax bracket is dropped to 32 percent in 2017, the tax savings will only be $144,000 on the $450,000 in deductions, a difference of $31,500. As demonstrated, accelerating these deductions into years with higher tax rates can lead to significant tax savings.
As mentioned above, we cannot be positive that the tax policies proposed in the campaign will be enacted. However, we can be relatively sure that the odds of increasing tax rates are slim with a Republican President, House and Senate. Based on this fact, taxpayers and preparers should be looking to recognize any depreciation possible in 2016.
If you have any questions about how cost segregation, fixed asset reviews, or 179D can be utilized to create these savings, please contact your McGuire Sponsel representative.