An Accounting Trick to Make More Money When you Sell a Property
November 1, 2010
Here’s an accounting trick that can help you get more for the property.
If you are doing, have done or will do any major repairs this year, make them capital expenditures rather than expenses. Most times you have that option. Anything that is added to a property and that will last more than a year can be considered a capital expenditure.
Planning to sell a property next year? For example, if you replace half a roof, you could make it either an expense or a capital expenditure. If you have a built-up roof re-tarred, you could call it either an expense or a capital improvement. If you repaint an apartment, you could even call that a capital expenditure.
Normally you would expense these items because it lowers your Net Operating Income (NOI), which in turn lowers your income tax liability. But a lower NOI means a lower price for a property. Here’s why.
Investment property is valued at least in part by using a capitalization rate. (Capitalization rate is calculated by dividing the Net Operating Income by the Sale Price.) Say a buyer wants a rate of 10 percent. Your gross income is $60,000, you have $30,000 in expenses. You also spent $10,000 on items that could be either capital expenditures or expenses.
$60,000 Gross income
$20,000 Net Operating Income
NOI divided by capitalization rate of 10 percent equals a $200,000 value for building.
Here you would depreciate the capital expenditures straight line over five years.
$60,000 Gross income
$28,000 Net Operating Income
NOI divided by capitalization rate of 10 percent equals a $280,000 value for building.
In this example depreciating one item makes an $80,000 difference in the price you could get for a building. Obviously if you were not going to sell the building next year, you would probably want to expense whenever possible. Check with your accountant to see how it would be work for you.
WARNING: While there is nothing illegal or immoral about this accounting method, if you use it you are ethically obligated to disclose your accounting method to your buyer.
If you are going to buy a building, watch out for this accounting trick. See if some expense has been capitalized to increase the NOI. If so, take that into account when making your offer.