Real Estate Tax Shelters for Passive Investors feat. Erik Oliver

Hello, future billionaires. Welcome back to another episode. Today we brought on a cost segregation expert, Erik Oliver, talking about cost segregation and how it impacts passive investors. And so if you are not familiar with this term, you definitely want to tune in because this is a very, very powerful tool to have in your arsenal when you're investing in real estate. And even if you are familiar with cost segregation, you've been investing for many years in real estate, you should still tune in because we talk about some of the changes coming down the pike, specifically how these rules of the tax code can be benefiting passive investors specifically, not just active investors. We also talk about the lazy man's 1031 and some ways that you can use these passive tax losses and carry those forward for future passive gains and how to really kind of manipulate your income to where you want to be and pay less taxes, which we all want to do. And so I had a lot of fun talking about taxes in this episode, which is not something I say very often. I think you will enjoy it as well. So we appreciate you listening. Again, if you like this podcast, really appreciate the support. If you're willing to leave us a review on iTunes or any other platform, we really appreciate that. So we can continue to share the knowledge and with the guests that we bring on and really appreciate you all. Hope you enjoy this episode. This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro-driven alternative investments, so your portfolio is best positioned for for this economic environment. Get started and download your free economic report today. Welcome back to the Invest Like a Billionaire podcast. I am your co-host Ben Frazier, joined by fellow co-host Jim Maffuccio today. And we are talking with Erik Oliver, who is the Cost Segregation Authority. And, you know, very excited to have Erik on, especially at this time of year. So this is, you know, being released right at the beginning of 2023. And there's been some changes going on kind of in the tax realm as it relates to real estate investing. And so we wanted to bring Erik on to kind of discuss what some of those changes are. And this is a primer for cost segregation. So Erik, thanks so much for coming on the podcast.

Yeah, thanks, Ben, for having me. I'm excited to be here.

Yeah. Well, for those that are confused by cost segregation, maybe they've heard of it, maybe they haven't heard of it. You know, give us kind of a primer on what it is and why is it important. And, you know, why do you want to be an authority in cost segregation? It sounds kind of boring, honestly.

No, that's a great question. My kids ask me that same question all the time. They're like, Dad, what is it you do for a living? So that's a great question, Ben. So cost segregation really is just accelerated depreciation. And so one of the benefits of owning real estate is that you get to take depreciation, which is a form of an expense. It's a non-cash cash expense. Just like any other expense, you get to take that expense against your income. And typically depreciation is either— you depreciate your buildings either over 39 years if they're commercial buildings, or residential buildings get depreciated over 27.5 years. And so just to make the math easy, if you were to buy a $275,000 single-family home, you're going to get about a $10,000 write-off every year. Over the next 27.5 years. So that $10,000 write-off, let's say you make $100,000 a year. Instead of getting taxed on $100,000, now you're only taxed on $90,000 because you have this $10,000 depreciation expense, correct? So that's kind of standard depreciation. We call that straight-line depreciation. But what if you could accelerate those deductions? So I may not own my home or my single-family rental for 27.5 years, and so I want to accelerate those deductions. And the way to do that is through a cost segregation study. And really what that is, uh, Ben, is it's just accelerating those deductions by segregating the different items that you purchase when you purchase a, in that example, a single-family home. So when you've purchased a single-family home as an investment property, you're not just purchasing the land and the walls. You're also buying some appliances. You're buying a ceiling fan, you're buying a garbage disposal, a washer and dryer. There's all these different components. You're buying a driveway, you're buying landscaping. And the IRS says that all these components should be depreciated at a faster rate than 27.5, because if you think about it, carpet doesn't last 27.5 years, right? Your driveway typically doesn't last 27.5 years. And so by having a cost seg study done, we come in and we take that again, in that example, a $275,000 purchase, and we segregate the costs into different buckets. We say, okay, Out of that $275,000, $20,000 of that was for flooring. $10,000 of that was for the driveway. $15,000 of that was for the landscaping. And we, by putting it in those different buckets, it allows us to depreciate that carpet over 5 years versus 27.5. It allows us to depreciate the driveway over 15 years versus 27.5. So you're just front-loading your deductions.

So, so there's, so there's a, there's a connection. There's a nexus between the particular item that's being segregated and its useful, typical useful life, right? I mean, that's, that's the kind of general principle behind it. So you can accelerate it because it's not going to last 27 and a half years.

That's correct. Yeah. The IRS is basically, there's a, there's a big book that the IRS has taken just about any item you can think of.

Of course there is.

Yeah.

They really make it nice and simple. Um, they take any item that you can think of and they say, okay, carpet. Gets depreciated over 5 years. Now the problem is, is that when you buy a $275,000 single-family home, you don't know the value of the carpet. You just look at it as one big lump sum of asset and you typically depreciate it over 27.5 years. But a custodian company will come in and segregate that and say, okay, you did buy some carpet when you bought that home. And that carpet is valued at whatever, $8,000, $10,000. And now you get to take that carpet and put it as a line item and depreciate that carpet over 5 years instead of 27.5.

And are those timeframes per item, are they set forth in the code somewhere, or is that, is that where you have some subjectivity or what?

Uh, there is some subjectivity. However, the IRS does publish an audit guide on cost segregation.

Okay.

Kind of the way this came, came about, Jim, was at some point someone took the IRS to court and said, listen, I'm not depreciating my flooring over 27.5 because flooring doesn't last 27 and a half years. So there was a court case where they said, you know what, you're right. Flooring only lasts 5 years. So we're going to change that to 5-year assets. So there's all these court cases and case law. There is some subjectivity to it, but there is an IRS audit guide that basically says in a building, the flooring should be depreciated like this. The countertops should be depreciated like this. And so there's an audit guide that we follow. Where they've pretty much outlined how all this stuff should be.

And those are, at the very least, those are safe harbors. Like if you use those timeframes, you're, you're not going to get questioned. But you could, if you could make a case that maybe the life of a component was less, you could, there, that's where the subjectivity comes in. You could push for, you could push the—

not so much on the individual asset. I think the subjectivity comes in, is this carpet worth $9,000 or $12,000? The additional value. Got it. Yeah. And so that's where the expertise of having somebody with a background in construction comes in to, to identify. And then not to get too, too complicated, Jim, but there also are like indirect costs that get factored in. Like when you build a building, you have to pull a permit, you have to get architectural fees, you've got construction loan interest. There's all these other outside indirect costs or soft costs that we also tie in and we put a value to those and those get divvied up amongst the different assets. So, yeah, it's more than just pulling the assets out. There's a kind of a process to it, but the IRS has published an audit guide that tells us how to do these. And so as long as you follow that audit guide, you're, you're pretty good. And again, there's a number of reasons why we want to do this, right? I mean, deduction today is worth way more than a deduction 26 years from now. Or again, I may not even own my building 26 years from now. So give me my deductions today. Let me go reinvest that money in a new duplex. Let me go pay down some debt. Let me go buy a boat, whatever it is you want to do. Give me my money today versus letting the IRS hold onto it.

And from an investor standpoint, I mean, this is very powerful, right? Because if you can defer taxes and you can redeploy those savings into other, you know, cash flowing or, you know, assets you can grow, then over time that's going to be very meaningful. And it's kind of funny as you're talking about The suing the IRS for basically, you know, paying taxes where any other business, you know, it doesn't work. But in real estate, you know, we, they basically created your whole industry through a lawsuit that they apparently won. And yeah. Way to go. Yeah.

So yeah, there was one, one big court case. It was Hospital Corporation of America. Hospital Corporation is a big outfit out of Tennessee. I believe they're headquartered in Tennessee. They have a bunch of hospitals throughout the Mid-Atlantic area. And back in, I believe it was the early to late, early to mid-'90s, they had some pretty savvy CPAs that said, hey, why are we depreciating this laminate flooring over 39 years? There was in the— there was a court case at one point that said it should be a 5-year asset. So they started doing— it's kind of when modern cost segregation was born, but they basically segregated all this stuff, created this massive deduction. And the IRS, they filed their taxes, saved millions of dollars in taxes. The IRS said, hold up, wait. What's going on here? What are you guys doing? And I'm like, listen, we're just doing what you guys have in your code. We're just interpreting it. Right. You know, they, what the IRS put forth was they basically said, if I were to replace my carpet, I get to depreciate that new carpet over 5 years. They never looked at it like when I buy a new building or an existing building and there's carpet in there, that carpet should be treated the same way as if I were to replace carpet in a building. Right. It's just no one knew how to pull those numbers out. And so that's where cost segregation kind of was born.

Got it. So I know there's somebody in the audience that's thinking, okay, you're talking about a tax savings, but aren't you just kicking the can down the road? And I think the answer in general is you're reducing the basis in the property, right? But then when you have an exit event that moves over to the capital gain side of the equation, and then if you're using like a tax-deferred 1031 exchange, you're continuing to kick that capital gain potential capital gain down the road. So it really is, it really is creating, it's creating money out of thin air in a sense. If you play it, if you exit properly, right?

Yeah. No, there's some strategy to the exit, but even like 1031s are a great tool because it does defer those, those two types of tax. When you sell an asset, you pay your recapture tax. That recapture tax is typically calculated based on the amount of depreciation you've taken. I think that's what you're getting at is I'm sitting here saying, hey, frontload all that depreciation, but when I sell it, don't I just have to pay it back? And the answer is no and yes. You do pay it back. If you don't do a 1031 exchange and you just pay it back as a capital gain, you're paying it back at the highest rate of 20%. But you're taking your deduction at like a 35 to 40%.

You're moving it into a different bucket altogether.

You're moving it into a different bucket. And we're playing a rate arbitrage where you're taking your deduction at 35, 40%. Paying it back at 20% and saving the spread. That's the first thing.

So even if you don't continue to defer, you win.

I mean, you already win right there.

Yeah. Yep. You just saved 15% on your taxes by taking a deduction at 40%, paying it back at 20%. Well, in that case, 20%, saving 20% on, in a rate arbitrage. That's the first thing. The second thing is you don't actually have to pay it all back. You pay a portion of it back. And so I'm going to kind of back into this example because I think it's easier, but Let's say you buy a building for a million and you sell it 5 years later for 2 million. If you don't do a cost segregation study, you're telling the IRS that everything doubled in value. I bought everything for a million. Everything is now worth 2 million, and you're paying tax on that million dollars of gain. But what are your 5-year assets worth after owning your building for 5 years? What's your carpet worth? It's worth zero. Zero book value anyways. Right. But when you don't do cost seg, you're saying, hey, my dirty old nasty carpet that I bought for $1 million is now worth $2 million and I'm going to pay tax on that. Well, carpet doesn't go up in value. Your land and your walls go up in value, but your personal, what we call personal property, your carpet, your countertops, your cabinets, your appliances, that stuff doesn't go up in value. That stuff goes down in value. And so your 5-year assets are worth zero on the books after 5 years, which means you pay no recapture tax on them after 5 years.

Wow.

If you don't do cost seg, again, you're, you're telling the IRS that that dirty, nasty old carpet you've had for 5 years is worth double what you bought it for 5 years later. And oh, and here, I'm going to pay tax on that.

And does that apply to all the accelerated, um, personal, uh, personal items in there? So if it's a 7-year or a 10-year depreciation schedule and you sell it in 5 years, whatever is remaining. In value is taxed?

Correct. Yep. So like typically on a cost segregation study, we take a 27.5 or 39-year asset and we move it into either a 5, 7, or 15-year bucket. So if you own your building for 5 years, that stuff gets no recapture. If you own it for 7 years, your 7-year stuff gets, falls off. If you own it for 15, your 15-year stuff falls off. So the longer you own it, the bigger your tax savings is essentially. But again, even if you buy it this year and sell it next year, you're still going to save that 20% on the rate arbitrage.

The difference between the— yeah, the rate.

Yeah.

Yeah.

Taking your deduction, even if you pay it all back, as long as you're paying it back at a lower rate, you come out ahead.

But then just to be clear, but, but if you do decide to defer it through a 1031, you're not paying, you're not taking that recapture and being taxed on it even at the lower rate. It's, it's just your new basis that moves forward into the next adventure, right?

Yep. You got it. So yeah, we have a lot of investors who buy a property, do a cost seg, 1031 exchange into a larger property, take that additional new basis, cost seg, you 1031, 1031, 1031. And then unfortunately all of us die at some point, leave that to our estate. It gets a step up in basis and nobody ends up paying tax on it.

I like it. Now, now, sorry, let's, let's pause there. 'Cause you're, so let's walk through that example again.

Yeah.

Uh, 'cause when you do a 1031 exchange, your basis doesn't increase, right? So your basis that we, so when you purchase the property, that becomes your basis. And when you, when you do a, you sell that property, you take those gains and roll into a new property. I guess that the, I guess your basis in that new property is established, but you still carry forward the, um, the, the difference that is your taxable deferred balance over time, right?

Correct. Yeah. So 1031, I always look at it like you already took some depreciation on that first property. And so when you defer it into the second property, that depreciation, depreciation you already took, you can't take that depreciation again on the second property. But a lot of people will exchange into a larger property. So let's say you bought the first property for $500,000 and you bought the second property for $1 million. You now essentially have an additional $500,000 of new basis that you can cost seg that has no depreciation taken out. And so as long as you're deferring into larger properties, it definitely is a good strategy to defer your taxes and never, never pay tax.

Well, one of the things I wanted to talk to you about, and I've, I've heard this being done, I've not personally done it, so I'm curious. It sounds too good to be true, but it seems like it might be possible. Basically it's called like the lazy man's 1031, right? So you take a property. So in your example, you buy a property for $500,000, you sell it for a million, and just for some simple math, you have a $500,000 capital gain. Well, then you go and invest that capital gain into another property that you also do cost segregation on, and the accelerated depreciation plus bonus depreciation in that year 1 that you take covers the full taxable income from your last property sale. And now your basis is at that new level and you don't have any kind of tax liability that you're carrying forward. Is that possible? Hopefully my example makes sense.

Yeah, I'll kind of walk through that example. That is a great example and it absolutely is possible. So I think one thing we need to touch on before we go there is just bonus depreciation. Yeah, we mentioned bonus depreciation. So let me just kind of touch on what that is. So back in 2017, when Donald Trump was president, there was a tax overhaul. It's called the Tax Cuts and Jobs Act. And with Donald Trump being a real estate investor, the tax changes were very favorable to real estate investors. And something came out of that. There's something called bonus depreciation that the, the, the government's had. It's been around for long before Trump was president. It's been around for a number of years. Bonus depreciation is always used as a kind of a lever to stimulate the economy when it needs to be stimulated. And so they say, okay, the economy's not doing great, so we're going to say Hey guys, if you go out and buy stuff, we're going to allow you to take those depreciation amounts much sooner. And so they give you a percentage. They might say it's, you know, for 2016, it was 50% bonus, meaning you go out and buy a million-dollar bulldozer. You get to write off $500,000 of that, or 50% of that in the first year. The other 50% goes, gets played out over the useful life of that bulldozer. And so two things happened with the Tax Cuts and Jobs Act. One is it went from 50% at the time up to 100% bonus depreciation, which was huge. The second thing is that back prior to that tax law, it had to be brand new equipment. You couldn't go buy a used bulldozer. You had to go buy a brand new bulldozer. And so they changed that and said, it just has to be new to you, the taxpayer. So let me kind of put bonus depreciation into context on how it works with real estate. Bonus depreciation only applies on assets that have a useful life of 20 years or less. I think the IRS did that on purpose because they didn't want bonus to apply to real estate. So they said, well, real estate gets depreciated over 27.5 and 39. So if we put this at 20 years, it won't apply to real estate. But what if you have a cost seg study done? Now all of a sudden we've got 5, 7, and 15-year assets where bonus does apply. And so under the current tax law, any properties placed into service between 9/27/17 and the end of this year, 2022, are eligible for 100% bonus. So remember, Ben, I talked about how we segregate those different items into the 5, 7, and 15-year buckets. So if you buy a $500,000 property, we typically segregate around 30% as kind of an industry average. And so $500,000, 30% of that is $150,000 that goes into those 5, 7, and 15-year buckets. Because those buckets are less than 20 years, they're eligible for that bonus depreciation, which means you get to take 100% of those deductions in the first year versus taking them over 5 years, 7 years, or 15 years, right? Instead of having to take one-fifth, one-seventh, or one-fifteenth, you get to take all of it in the first year. And so that's been a huge advantage for real estate investors to be able to really maximize it. It's basically taken cost segregation and put it on steroids, right? Because instead of accelerating stuff to 5, 7, and 15, we're now basically accelerating it to 1 year because it's 100% or all of it in the first year. So I just wanted to touch on that because I think that's important to your example.

No, that's very helpful. And just to create further context, so without bonus depreciation, What percent of your capital invested in a given property could you expect to have a year one deduction on? Just percentage-wise, rough, rough estimate.

Yeah, that's a good question. It's hard to answer that just because I do want— and I've kind of oversimplified things. Let me just make it clear that land is not depreciable, right? So if you buy a million-dollar property in Oklahoma and the land is worth $100,000, that means you have $900,000 of depreciable basis that gets spread out over 27.5 or 39 years. That same million dollars, if you go buy a million-dollar property in LA, LA loves their land. California in general loves their land. So their, their land value might be $800,000, which means you only have $200,000 of depreciable basis. But once you've established that depreciable basis and you've subtracted out the land, you can anticipate about a 30% segregation on that and on that depreciable basis. So again, if you buy a property for $1.2 million, you determine the land is worth $2 million, or excuse me, $200,000. That gives you $1 million of depreciable basis. You should get about $300,000 of deduction in that first year if you apply the 100% bonus depreciation.

Okay. So let me ask a couple of questions, a two-part question then.

Yeah.

So, so there's, so there's the, the bonus depreciation, which was kind of an add, kind of taking something that's already good, the, the You know, the cost segregation, different shorter lifespans and putting, just turbocharging that.

Exactly.

Are either or both of those restricted to certain kinds of taxpayers or are these available to the person on this podcast that's just thinking about buying their first property? Say they're a medical doctor. Are there any, is this for everybody?

That's a great question. So cost segregation is not necessarily for anybody and everybody. One thing you have to remember is typically real estate deductions are considered passive. So in that example you gave where, let's say I'm a doctor and I, I full-time anesthesiologist, that's what I do full-time. I've got a few rental properties on the side. If I do cost segregation on those rental properties, the deductions that I create through bonus depreciation and cost segregation, those deductions can only be used to offset income. That's considered passive or my real estate income in that example. So I might make $500,000 a year as a doctor, but those deductions that are created, even though they're large, they're supercharged with all this bonus. I might create a $300,000 deduction. I can't use that $300,000 to offset my tax liability from my $500,000 of W-2 active income. So you've got tax—

even if you're an anesthesiologist and your very, your very job is putting people to sleep. That's not considered, that's not considered passive.

No, that is not. Okay.

All right.

So I just want to make sure that's clear to our folks watching that.

Yeah, absolutely. There's two types of income. You have your active income and that's what you do every day for a living. Now, some people are real estate investors for a living, right? So one thing that we see quite often, I'll just go back to that doctor example, is if I'm making $500,000 a year, my wife probably gets to stay home because I make good money as a doctor. Well, she stays home and she manages my real estate. We say that she's the real estate professional because she is, as, as put out by the definition of the IRS, she spends 750 hours a year doing real estate. She does it more than 50% of anything else she does. If she meets those qualifications, she's our real estate professional. And now those deductions can be used to offset my W-2 income because we file a joint tax return. And those deductions become active. They can hit my active income. And so a lot of high W-2 earners who have stay-at-home spouses will try and qualify their spouse as a real estate professional so that they can take advantage of that and offset that high W-2 income. But that's a great question. It's not for everybody. Gotcha.

But let's go back to the passive because that's kind of more the focus of our investor base and listener base and You know, so even though it does only give you deductions against your passive income, it does kind of go to the point I raised earlier of if you have capital gains from investments, that is, you know, passive income and that can be used. And these losses, if you can't use them, do carry over, right? So you can be storing up these losses, even if you can't use them in a given year they're generated for future passive income. So talk a little bit about, about that.

Yeah, no, I'll think I'll tie that back to your first example, kind of the poor man's 1031 exchange, because there are limitations if you have, there are limitations if you're a passive investor. Again, you can only use these deductions to offset your passive income, but if and when you sell a property and have a large capital gain, that capital gain gets treated as passive income. And so those deductions now become activated. I don't know if that's the right technical term. Activate those that don't, don't look that up on the IRS website, but those become active and now you can use those deductions to offset that gain, which means you're not paying any capital gains tax.

Is that capital gains outside of the real estate investment thing too? Like what about, what about the sale of a stock portfolio? Would that, the capital gains generated from that?

Typically not. Typically only from the real estate. So there are different types of capital gains, but typically only from real estate. If you sell real estate and you've got this passive loss sitting on your books that you can't be used, once you sell that asset, creates a capital gain, activates the losses up to the amount of the gain. Got it. And here's something that's really cool. Let's say I have a $200,000 capital gain and let's say I have $300,000 of, of passive losses kind of sitting on my books, right? They're carrying forward, right? Sell a property, have a $200,000 capital gain that activates $200,000 of this loss. I have $300,000, but I don't get to use all of it. I only get to use $200,000. But when I use that $200,000, it actually is going to hit on my tax return against my W-2 income, which is great because my W-2 income gets taxed at 35%. So that loss hits my W-2 income before it hits the capital gain, which means I pay tax on the capital gain, but I just offset my 35% bracket by $200,000.

So it's the capital gain that triggered your ability to use it, but you don't have to use it against your capital gain.

Yep, exactly. The capital gain unlocks it, but then the way that it hits the tax return, it actually hits against my higher tax bracket W-2. Did you know that, Ben?

I did not know that. And you need to, you need to create a product. That's a button that says activate and you just hit that button.

Once you're ready to go, you just go, you just go tell people, hey, sell me your property. That's a good, it's good strategy.

Yeah, no, it works very well. We, the owner of our company here, we actually own this building here. And so, and that's exactly what happened. We did a cost seg study. It activated those passive losses and it actually hit against his W-2 income before. And it's just the way the tax return, just the way those numbers flow through the tax return.

Wow.

That's amazing. I'd rather, I'd rather pay my tax on my 20% tax bracket, my capital gains bracket versus my higher 37%, um, ordinary income bracket.

So what's the carry forward period on these accumulating passive losses that are gen— that can be generated?

That's a great question. So with the Tax Cuts and Jobs Act, they actually extended it from 20 years to indefinite. Oh, so let's— I'll use an example here. Let's say I'm a passive investor, so I'm a doctor again. I've got a couple of rental properties. They generate $20,000 of income every year. I do a cost seg study on one of those properties. I create a $100,000 deduction. I'm going to now pay taxes on my passive income for the next 5 years because I remember I'd make $20,000. So I'm going to wipe out $20,000 this year. That leaves $80,000 on the books for next year. Wipe out another $20,000. I'm down to $60,000. I do that for 5 years. I pay no tax on my rental income for 5 years. Those loss, those deductions never expire. They just sit on my accounts. I eventually use them, or as you mentioned, Ben, I sell a property and that gobbles them all up, you know, at once. But lots of, lots of ways to apply those deductions.

Correct.

Yeah.

And I think, well, one of the challenges, you know, as passive investors, is it can be very difficult to do a 1031 exchange when you're in a syndication. In fact, you know, it's very difficult to do because you have, I mean, you want to get into all that, but you know, so this kind of, you know, lazy man's approach is very attractive because it allows you, because the 1031 in all of its, you know, you know how impactful it can be, it is very difficult to do and it creates certain constraints and challenges, especially if you're in a syndication. So as a passive investor, if you can build up these passive losses and use it against your future passive capital gains, you can effectively remove not even a tax deferral, but actually, to your point, pay those taxes against the higher bracket income, which is pretty cool.

That's, yeah, that's a big one. Absolutely. Yeah, no, and I should say cost segregation is one of the few tax tools that I'm aware of that's so flexible. So a lot of expenses, like if I were to go put a deck on my rental property, I have to take that expense in the current year. I don't get to hold onto it, decide when and if I get to use it. Cost segregation, you don't have to do it in the year you buy a property. So let's say you've bought, let's say you bought a property in 2014. Never did cost segregation, and now all of a sudden you've sold the property, you have a capital gain event, and now you, you know, you're in a tax situation. I can go back and do cost segregation on that property I bought in 2014, pull those deductions forward, offset my current capital gain, and pay no taxes. And so cost segregation, you may not need it this year. You just keep it in your pocket until you do need it. And then you play that card and say, okay, I'm going to do cost segregation this year on this building. Because I need this amount of deduction. So you can really, if you've got a good CPA who focuses in real estate, you can really do a lot of great tax planning with cost segregation and, you know, apply it to different exit strategies or, um, there's a lot of useful ways to take advantage of it.

So why would you wait to do it if you can carry those deductions forward anyway?

Yeah, if you can carry them anyway, what's the point?

So you would wait. The only reason you would wait is one, well, two reasons. One is you have to pay for a study. So you don't want to pay me $3,000, $4,000 for a study. If you can't use those deductions for 2 or 3 years, just wait 2 or 3 years, do the study when you need them and take advantage of them. That's the first reason. The second reason would be it doesn't always make the best, it's not always the best strategy to wipe out your income to zero. So let me back that up. So if I make $20,000 this year through my, let's say I don't work, I have a couple of rental properties, I make $20,000. That's going to put me in a real low tax bracket. So I might be okay paying 10%, 5%. I don't, I don't have my tax bracket sheet here in front of me. I don't know what the tax bracket is on $20,000, but it's not a lot, right? It's a very low tax bracket. So I don't, I'm okay paying 10% this year at $20,000. Now, next year when I sell my property, I have another property that I sell and all of a sudden I have a $500,000 gain. That's when I, that's going to put me in a much higher tax bracket. And that's when I want to use my cost seg study. Makes sense. No, it doesn't always make sense just to wipe it out to zero. Even, um, one of the nice things with bonus that we'll, we'll strategize with CPAs all the time is when you do bonus depreciation, it might create a $500,000 deduction. But if you only have $100,000 of income, maybe it doesn't make sense to wipe that $100,000 down to zero. Maybe you only want to wipe it down to $40,000, put you in that lower tax bracket, and then you save the rest of those deductions for next year when you've got money in those higher tax brackets. So you want to use it to manage your tax brackets.

So you can, you can specify that I don't want to use everything I've got in the bucket, right? Or that I'm, that I'm allowed to use this year, I only want to use The amount that brings me down past that threshold.

There are tools to do that. You can't specify and say, I need exactly $36,000 of depreciation. But in that example where we use bonus, the IRS allows you to opt out of bonus depreciation by class. So what a lot of investors will do is they'll say, give me my bonus depreciation on my 15-year bucket, because I'm not going to own it for 15 years. My plan is to own it for 7 years and get out. So give me my bonus at my 15-year bucket, my 5 and 7, I'm going to let them spread out over 5 and 7, which means I'm not getting such a huge deduction in the first year. I'm getting it over 5, 7, and I'm getting, you know, a big bump in the first year because I took bonus at my 15, my 5 and 7 play out. So there are ways to strategize or manage those deductions to kind of hit whatever target you're trying to hit in terms of deductions.

So it can be a real planning tool.

Absolutely. Yeah, absolutely.

So Eric, talk a little bit about the changes in this year, 2023, as it relates to the bonus depreciation.

Yeah, that's a good question. So when the Tax Cuts and Jobs Act came out, bonus depreciation had a sunset date of December 31st, 2022. So right now, any properties again from September 27th of '17 through December 31st, 2022, that go into service in that timeframe, you'll get 100% bonus. Anything that goes into service starting next year is eligible for 80% bonus. So instead of getting 100% of your deductions in the first year, let's look at your 5-year category. Instead of getting 100% of your 5-year assets in the first year, you're going to get 80% of that. The other 20% gets spread out over the next 4 years. So still putting cost segregation on steroids because remember it's, we used to do cost seg studies before bonus was even around. Taking a 27.5-year asset, moving it to 5 years is way better. But now we're moving it to 5 years and then taking 80% of that and moving it to a year. And so, um, the way the tax law reads right now, every year starting in 2023, it lowers by 20%. So 2023, it's 80%. 2024 at 60%. Oh wow. All the way until 2027 when it's down to zero. Now I will state that there was serious talks in this last round of Congress with this lame duck session, with the economy kind of shaping up the way it was. There was some serious talks about extending bonus, 100% bonus into next year. It didn't get through on the final bill, but just because that's the current schedule doesn't mean they can't get together at any point. Hey, the economy's really struggling. Let's just reinstate 100% bonus and try and get people to go out and spend money. So that could happen next year depending on kind of how things shape up, but currently 80% starting in 2023, then 60% until 2027 when it's down to zero.

Yeah. And so your expectation, you were saying earlier in your example of the $1.2 million building where $200,000 of it is land, you got a $1 million depreciable part of the property. You can get roughly 30%. In a year one tax deduction. What would you expect that to go to now that bonus is going to 80% versus 100%?

Yeah. So you're, you're going to get, let's say, let me do the math here in my head. So on a million dollar property, we're going to segregate about $300,000 of it into those short asset lives. You're going to get 80% of that. So you're going to get $240,000. Plus you're going to get some straight line depreciation on your 27. So you're probably around $250,000, $260,000 versus Getting 300%. Yeah.

So, so still very, very, very impactful.

Yeah.

And you know, not as good as it was, but still way better than it has been. And yes. And I, I would make the point too, that's, that's if you're purchasing this property, you know, with, if you're purchasing it with, with debt, the percentage to your equity in the property is much higher than just those numbers. They're gonna be high. I mean, I've seen deals where it's 75% of your You know, capital contribution is, um, has a tax write-off in year 1.

Yeah, no, that's a great point. So remember our depreciation, what we're calculating it on is purchase price. So I may take only $200,000 and go put it down on a million-dollar asset as a 20% down payment. When I do the cost seg study, I'm doing it on the million dollars. So I get 30% of that. All of a sudden I got a $300,000 deduction on a $200,000 investment. And so you're absolutely right. The more you can leverage, the more impactful this could be in terms of getting a deduction on your contribution.

Got it. Very cool. Last question I have, you know, I've always kind of wondered this, but what, how would you kind of rank asset types from a, you know, what's the best asset to get the most cost segregation, you know, in year 1 versus the kind of the worst?

Yeah, that's a great question. So there's kind of 3 unique outliers. So typically I mentioned a couple times it's around 30% segregation. So your multifamily, your office building, your retail, those all kind of fall within 27 to 35%. Warehouse industrial is a little bit lower because there's less personal property, but there are a lot of land improvements. You think about a big warehouse usually has big Lots of concrete, lots of curbs, gutters, asphalt, drainage. So, but I would say your industrial is a little bit lower. Uh, your warehouse is a little bit lower. And then as you work your way up, you've got office, multifamily, retail. Medical seems to be a little bit on the higher end because you got a lot of specialty plumbing, specialty electrical. And then there's those 3 outliers. There are car washes, which are amazing. So you can buy a million-dollar car wash and you may get a million-dollar write-off in the first year. And the reason for that is, well, I'm oversimplifying again. Let me back out land. You buy a million-dollar car wash, you back out $200,000 for land, that gives you $800,000 of depreciable basis. You very well could get an $800,000 write-off. Because if you think about it, when you buy a car wash, what do you buy? You're not buying a building, right? You're buying land improvements, which are a 15-year asset eligible for bonus. And you're buying equipment, which is also a short-term asset eligible for bonus. So those self-serve bays where there's no sitting area, there's no building. Again, you buy a million-dollar car wash, you could get an $800,000 write-off in the first year. So car washes, gas stations are unique because gas stations, if you sell more gas, which you typically do than convenience, like then, you know, snacks and stuff, then car gas stations can, you can classify the whole gas station as a 15-year asset. And again, because 15 gets bonus. You just took bonus on your whole purchase. Wow. Gas stations. And then the third one is, um, trailer parks, mobile home parks. Again, when you buy a mobile home park, if there's no clubhouse or laundry facilities, you're just buying land improvements and trailer services, cement pads, electrical, sewer systems. All those are 15-year assets, which means you get a 100% bonus under the current law on those 3. So those are kind of the 3 outliers that are just way out there. Most stuff's going to fall between 25% and 40%. Multifamily is a great asset class because a lot of— if you buy a 100-unit apartment building, you got 100 washers and dryers, you got 100 garbage disposals, a couple hundred ceiling fans. And so they're great asset classes as well. Man.

Well, Eric, I've never had so much fun talking about taxes.

You know, I know, I know. That's impressive.

Or the lack thereof, I think, is what's the most exciting.

That is the exciting part. I love talking to you. Right. I love what I do just because it's kind of the good side of taxes. I've sat in a lot of tax seminars where it's, you know, no one likes to talk taxes. But if you can tell— if you can talk to me about how not to pay taxes, I'll listen all day long. So I appreciate it.

Awesome. Well, Eric, if folks do have active investments or even if they're into passive deals and, you know, want to encourage sponsors to get cost segregation, if they're not, what's the best way to reach out to you?

Yeah, so you can reach us on our website. Our website's just www.costsegauthority.com. That's S-E-G-Authority.com. Um, my contact information's on there. Please use us as a resource. We don't bill by the hour. We're kind of a unique accounting firm where we just do these cost segregation studies. And so we partner with your CPA. CPAs are kind of like your general practitioners. They know a little bit about thousands and thousands of pages of code. We dive deep just into one section of the tax code. So we're kind of like the brain surgeons. And so they'll usually partner with us when they have a client that owns real estate and say, hey, can you run some numbers? We always do a free analysis. We never want to engage with somebody if they're not going to save significant tax dollars. So, you know, if you buy a property, you can give us the closing statement and we can come back and say, hey, based on the information here, we anticipate increasing your depreciation by X amount, the study's going to cost you X amount, and then you can decide if it makes sense from there. So always get a free analysis done on any revenue-generating property. I would always suggest you get analysis done just so you can use it for tax planning and, and kind of going forward. But yeah, please use this as a resource. I, I always joke, I think the weirdest question we've ever been asked is how to depreciate deer at a breeding facility in Wisconsin. Um, I didn't know the answer, but I was able to talk to one of the guys upstairs and get the answer for him. And so. Um, what was the answer? I don't remember. It's, it's similar to livestock, but it was one of these breeding facilities where they, they had all this land and they take these, these, uh, bucks and they breed them to have these huge antlers. Then people pay ridiculous amounts of money to sit on the porch and kill these things. Um, there was a specific way to depreciate those, those, like I said, it was kind of treated similar to livestock, but, um, again, we can find the answers if it's Anything to do with depreciation, we'll get you the answer. So please use that. Yeah. That's awesome.

Thanks so much for, uh, for coming on. I definitely learned a lot and hopefully our listeners gleaned a lot of information as well. And, uh, appreciate you sharing your wisdom.

Yeah, no, thanks. Thanks, Ben. Thanks, Jim. It's been great. Um, yeah, thanks for having me.

All right. Thanks so much.

Take care.