You may have noticed that this “Debt and Taxes” series is being done differently than our previous e-Newsletters. I initially wrote one long e-mail, but soon realized it was too much information to soak up at once. As a number of you have suggested shorter e-mails, I decided to divide this topic into daily sections. Please continue to ask questions and let us know what you think about this format and our e-Newsletter, and thank you for reading!
In Part 1 of “Debt and Taxes” I talked about taking out a mortgage, both as an alternative to renting and as a way to leverage inflation. But it’s also a great way to make the tax code work in your favor: mortgage interest is tax deductible. Most other types of consumer interest are not deductible (e.g., car loans, credit card debt and most student loans). So it makes sense, if you must borrow, to favor mortgage debt over other forms of consumer debt, so long as you don’t overextend yourself as many did during the last decade. Yes, there are times when non-deductible debt makes sense, but you should approach each potential loan on a case-by-case basis, preferably with the help of a financial professional.
One type of borrowing that’s particularly beneficial from a tax standpoint is business debt. Not only is the interest almost always tax deductible, you get to write it off “above the line”—before calculating your AGI (adjusted gross income). In general, deductions from AGI result in bigger tax savings than the equivalent itemized deduction on Schedule A.
Other business benefits
Business owners have a plethora of opportunities to reduce or defer taxes, and I personally take advantage of every one that I can. In addition to writing off business interest, you can deduct most purchases of computers, other equipment, software, furniture, etc. (Just be careful not to do a Leona Helmsley and write off $8 million of home improvements as if they were business expenses!) A part of the tax code known as “Section 179” allows many of these deductions to be taken immediately in the year of purchase rather than spread out over time as depreciation.
Speaking of depreciation, this is, along with amortization, another great tax-saving vehicle. Depreciation refers to the decline in value over time of physical items such as buildings, furniture and equipment, while amortization denotes the same thing for “intangibles” such as copyrights, patents and client lists.
We all know about real estate depreciation: you buy a building with mostly borrowed money, and then write off a portion of the purchase price every year, including the part that you borrowed. While most non-residential buildings are depreciated over 39 years, other types of structures have faster schedules (e.g., 27.5 years for residential real estate). There’s also something called “cost segregation”: many parts of a building depreciate much faster than the building as a whole and thus can be written off more quickly. For example, in an office building, you can depreciate the furniture and fixtures over 7 years instead of 39.
Be on the lookout for Part 4 where we will discuss retirement plans and how to most efficiently manage them from a taxability standpoint!
Dr. Ken Waltzer MD, MPH, AIF, CFA
Founder and President – Kenfield Capital Strategies (KCS)