442: Tax Talk: Understanding Cost Segregation and Other Key Strategies for Real Estate Investors with CPA Amanda Han

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It is my pleasure to welcome a returning guest back to the show and that is none other than CPA and author Amanda Hahn is back with us. Amanda, welcome. How are you?

Yeah, I'm excited to be here. Jason. It's been a while since we chatted last time during COVID Lots have changed.

It has been a while for sure, and it's good to have you back, Amanda. You know, there are so many things to talk about in tax law. There's pending legislation. We don't know who the next administration will be. There's just a lot of things going on. What do you want to talk about? First, why don't I give the floor to you and you lead us with that. But I've got a whole list for you. I want to talk about cost segregation, maybe a little bit about 1031 tax, deferred exchanges, real estate, professional status and more. So keep listening folks.

Yes, I mean there's so much to cover. But it's interesting you brought up the, you know, obviously that with election year coming up, tax is always a hot topic, right? Depending on who is going to take office and all that good stuff. But I think what's really interesting for us to know is that currently There is a 2024 budget proposal and not unexpectedly, there are a lot of the proposed changes are actually detrimental to real estate investors. But I want to first start by saying answering question of what are the odds any of these proposals will actually pass? Of course I don't have a crystal ball, but I know most professionals in our field, in the accounting field feel like there's very little if any chance of any of these current proposals passing. Why do we say that? Well, because these proposals have been around or have come up almost every year on a lot of the same things. And so but nonetheless, you know, not unexpectedly within the proposal are limitations to 1031 exchange. So I know we'll touch on that a lot more in depth later on. But limiting our 1031 exchange opportunities again also maybe higher taxes for higher income individuals and I know, you know, when I talk to people, because we just passed the tax deadline and when we talk to people, majority of folks still feel like they pay too much in taxes. It's not surprising. Like, who says, I don't think I pay too much in tax? Almost.

Well, Warren Buffett says that, but he's such a hypocrite because he, he got in a big lawsuit with the IRS after he said that. I mean, it's just, you know, it's just ridiculous. But anyway, go ahead. Yeah, most people. Absolutely right. Nobody, nobody says I want to pay more.

Yeah, yeah, exactly. I mean, taxes really is a silent killer of our wealth if you think about it. I mean, I think most people who kind of, you know, work full time, we're just always looking at how much taxes do I owe in April. But they're not looking at how much are they actually paying because a lot of that comes out of their paycheck now. You don't even see it. So these are like just the different tax rates we're paying right now. Federal highest rate is 37%, depending on what state you live in, 13% or even higher payroll tax, capital gains, estate taxes. And what's really interesting is not many people are talking about it, but depending on who takes office at the end of 2025, it. The current law says tax rates will actually be even higher than what we see on the screen. So instead of 37%, the marginal rate is scheduled to go up to 39%. So we got to keep that on the radar, you know, like when we complain. No, it could be much worse.

Yeah, yeah, no question about it. Okay, good. Well, as I always say, you might be bored talking about taxes. Most people are, unless they're cp. But this is a very important topic, folks, because it is the largest single expense most anybody has in their life. You know, not, not everybody, hopefully real estate investors. You know, we, we deal with the most tax favored asset class in America. So it's a great asset class, no question. But talk to us about some specifics in areas where we can save on taxes. If you're ready, I'd kind of like to go into cost segregation. And by the way, I do want to say to our listeners and viewers, we do have two really good sources that do cost segregation very economically for single family. That wasn't always the case. Usually in the past. I remember I did a cost segregation study on 125 unit apartment complex I owned and I paid like $22,000 for that. And usually cost segregation, which is A huge tax savings opportunity. If you don't know what it is, keep listening, Will tell you was limited to bigger commercial properties. But with technology and with entrepreneurship and innovation, there are companies out there that offer this now for 5, 600 bucks. It's pretty incredible. And we've got some good sources that a lot of our clients have used and been very happy with that can save you a ton of money on taxes. But can everybody use it? Maybe some people can't use it or. Well, let's first talk about what it is, because some people don't know. Maybe you want to explain it, Amanda, go ahead.

Yeah. What I love about, like you were mentioning, real estate is one of the best asset classes when it comes to tax efficiency. And so, and that's really for two reasons. One, when you're a real estate investor, you're a business owner, eyes of the irs. What does that mean? What that means you can now write off business expenses as an investor. So not just like mortgage and property taxes, but, but also just your expenses that you might have, you know, like car expense. You're using your car for your real estate. You have a home office for your real estate. So now we get into this arena of being able to shift some of these personal expenses into legitimate business deductions. But really, I mean, you know, how much of those can we shift? Right. And so when you hear people talk about I made you know, 100,000 or $300,000 of income and I paid no taxes, odds are very high. They're using cost segregation. And so, you know, as real estate investors, we get to take depreciation, which is a paper write off on the purchase price of the building. Traditionally, you write it off over 27 and a half years. If we're talking residential real estate. But the IRS gives us a lot of flexibility in how we take depreciation. And so instead of just taking it evenly over 27 and a half years, we can say accelerate it.

Right?

And that's where the cost segregation comes in. It's where an engineering firm look at your property and says, well, instead of just calling this, you know, $300,000 building, let's break it out into components of specialty plumbing, of appliances and fixtures. Then your tax person can create faster depreciation that way or faster paper lots, basically. Right?

Yeah, it's pretty great. So. So just to add on to what Amanda is saying, so basically, you know, when you buy a property, you're not buying one single component. You're buying two major components. One is the land, the other Is the improvements sitting on the land, the house, the apartment complex, the shopping center, whatever it is. Right. IRS says at some point that improvement will have no economic value. It'll fall to the ground. Right now, their schedule for that end of its economic value is completely irrelevant to reality. It has nothing to do with reality. It has to do with probably lobbyists lobbying Congress. And that's. That's how laws get made in America, folks. So. So they've decided that 27.5 years is the number for residential, 39 years for commercial property. So residential has a better schedule because you get to write it off faster. But certain components of the property can be scheduled for quicker depreciation over five or seven years or others are different times. And so what this does is it brings that tax benefit forward where you get to take the benefit sooner rather than later. And, you know, if I can have a benefit sooner, I'd rather have it sooner than wait for the benefit. Right. So this is a really incredible opportunity. It's super cheap to take advantage of it. And let's go into that a little more now. Amanda, I just wanted to explain that to further help your explanation.

Yeah, and I love that you were saying how before you paid, what is that, $22,000 for cost segregation. And we've really seen. And that's still a huge misconception.

And it was worth it. It was completely worth it. Yeah, yeah.

It is a huge misconception in the tax world where CPAs will advise their clients that, you know, the cost segregation is only good for large apartments, commercial property. But we have seen it to be very beneficial, even for single family duplexes and smaller properties, like you were saying, because of, because of innovation and things like that. And also as a result of COVID Now a lot of the studies are done remotely, so it's much cheaper. And also with bonus depreciation, you know, currently in 2024, we have 60 bonus depreciation, which means we are accelerating even more into the current year rather than having to wait even five or seven or 15 years. So with lower cost, bigger upfront benefit, that's what we're seeing. Even smaller properties will really get a benefit. But as amazing as it is, you know, whether you, the listener should do a cost segregation or not is really going to depend on your situation. So cost segregation is not optimal for every single person. It's going to depend on your ability to utilize the accelerated depreciation.

Right.

So in the simplest form, you know, before you go out and get a cost segregation study, talk to your CPA and ask them, you know, can I use this benefit to offset my different types of income? If so, then you maybe want to consider it. If not, it just means that might be a better strategy for you in a future year.

Yeah. Okay, great. So who can't use it, for example, or who can use it? Most people can use it, but you can't always use it in the same way, Right? Yeah.

I mean, so I think the misconception is who can do a cost segregation? And the answer is everybody. Okay, so everybody can do a cost segregation. Then the question becomes who should do a cost segregation? And the people who should are the people who can use it to offset some type of income in the current year. So if we start at the baseline, you know, if you are someone who has very high taxable rental income, so you got some older properties, debt paid off, depreciation already done, you bought some new properties, well, it could make sense to do a cost segregation of the new properties because we know at a minimum we can use this to offset the rental income of some of my older properties where paying taxes on. Right. So that's.

So let's just talk about that a little bit because like this, this is my mother's situation on a lot of her properties still that she's owned for decades. And the depreciation schedule has run now, thankfully she has been selling some of those off and doing 1031 exchanges into new properties. And you know, she can start that schedule over, she can lever them up so get, she can get a much better return on them and they're in better markets. So you know, she's gotten out of California, those old properties that she had for decades and you know, purchased properties, Florida, which are a much better deal. And so the situation you're describing is her situation on those older properties because if they're paid off, she has high rental income and all that rental income becomes taxable. Another reason to leverage your properties, folks, so you'll have less income on purpose. Okay. And you'll have more cash because the borrowed money on the refi TDI program we teach is not taxable. There's no tax on borrowed money. So that's, that's the way you want to manage your portfolio and your wealth. But back to the cost segregation so you can benefit from, from it, to write it off against rental income. That's great. So that's. Even if your income is high and your depreciation write offs have phased out, if you're over 150,000 AGI. Right?

Yeah. You're exactly right, Jason. I was just talking to another client the other day about his mother. It was the same exact scenario. So. So at a minimum, who can benefit from a cost segregation is those people who have taxable income from their other rental properties. Because we can always offset different rentals. You know, one has income, one has lots. We can always offset the two. And this is true regardless of how much other income you make and whether or not you're a real estate professional. So you don't have to be a real estate professional to be able to offset rental income with rental losses from a cost segregation.

Good. So the real estate professional thing is hard for some people to qualify for. It's a fantastic gift from God. If you can qualify, it's wonderful. But it is hard to qualify for in many cases. So the cost segregation can still benefit you if you have a high income and if you're not a real estate professional. So that's really good news. I'm sure a lot of people will be glad to hear that. But you need passive income to take the deduction against, right?

Yeah, yep, exactly. And this is where I have a major problem with CPAs who tell people, you know, don't invest in real estate because you don't get any of those benefits that people are talking about like cost segregation. And that's not true at all because we just went over an example of where that makes total sense. And I would argue to say if you're someone who's in a very high income, let's say doctor or an attorney, where you're paying over 50% taxes between federal and state. Well, being able to earn rental income and not pay taxes by using write offs and cost segregation, that's absolutely. Taxes saved. Right. Because where else are you earning money that you're not paying taxes on?

Yeah, okay, good, good. Anything else on cost segregation? This is really a fantastic thing, folks. You can go to jason herdman.com costseg just go ahead and fill out that little quick form there and we'll get in touch with you about that because it really is a fantastic opportunity. Okay.

Yeah, I mean, think, you know, I mean the whole conversation with cost itself could probably be like an eight to ten hour class, I think.

A cure for insomnia.

Exactly. Well, so I think a couple of things I see a lot misconception. So cost segregation, if this is the first time you're hearing about it, okay, you can still do it. You don't have to do it the first year you buy property. So maybe you've Owned properties for two, three, four years.

And that's what's called a look back back.

So yeah, this is the first time you're hearing Jason talk about it or Jason I talk about it. So you can do what's called what we call an accounting method change. So basically, let's say on the 2023 or 2024 return, you can actually change your method and do a catch up on all the stuff you've missed and then get a huge benefit for it.

It's really an incredible folks. The other thing you can do, by the way, at the time of this recording, we are past the tax due date. However, if you filed an extension, you can still get the cost segregation study benefit for last year. If you're on extension, it's really beneficial to file extensions. Okay, go ahead.

Well, you know, right now, I don't know how much you guys typically talk about it, but you know, bonus depreciation for 2023 was 80%. 2024 now is 60%. There is actually a bill that's made it through the.

And it's probably going to pass. Go back to 100%.

Yeah, yeah. And so that's one of the main reasons we're having a lot of our clients go on extension because if it passes, it's currently designed to be retroactive to 2023. So now here's the funny thing. IRS has said that if, you know, things were to pass and obviously people had to file their returns, they will automatically adjust your taxes and give you a refund. But I bet nobody will trust the IRS to actually do that or do it correctly.

Yeah, folks, the more you know, that's why you're listening to the show. This is really incredible. Like what we just talked about alone could save you a fortune in taxes. So take advantage of it. Go to jasonrman.com costseg s e g cost seg for cost segregation. Okay, what else should we talk about? Do you want to talk about Real Estate Professional? A little bit? Just quickly. You know, this has been a thing for many, many years. We've done shows about this in the past. You can go to jasonrman.com look up those shows, just type Real Estate Professional. But you know, just remind people of what that is, why it's so great. It doesn't mean, folks, that you need to be in the real estate business per se. It's just an IRS designation is what it is. But it's pretty incredible if you can get it. Go ahead.

Yeah, so real estate professionals. So the in the tax world, there's there's a set of rules called passive loss rules. And the simplistic way to explain it is if you're someone whose real estate is not your full time gig and is more of like a side hustle and your income is over $150,000, then your rental losses are considered passive losses, which means they offset, you know, rental income and other passive income, but it doesn't offset taxes from your W2 income. Or if you have and that's not real estate, it doesn't offset that type of income. And so it's not the end the world. It just means you can't use it right now. You don't lose out on any of the benefits. They're just delayed. So they're delayed into the future. And you can always use it to offset taxes from future income that's passive. Or you can use it to offset all types of income when you sell that specific property. Okay, so, but nonetheless, if you're someone or married to someone with high income and you own rental real estate, there is a loophole around all those, all those rules. And that is if you or your spouse is a real estate professional, then you can use rental losses is to offset all types of income rather than just rental or passive income. So I think the misconception is people think, well, to be a real estate professional, do I need to be a realtor? Start showing houses on the weekends. And that's actually not what the IRS is looking for. They're looking for a set of hours that you're earning in real estate and activities that you're doing in real estate.

So, so, so Those hours are 750 hours as a real estate investor or in the real estate business, how the IRS defines that. But 500 of those hours need to be what's called material participation, meaning you have to actually be involved. And folks, this is another reason to do the hybrid self management plan we recommend. And you know, we really want you to get control of your investments, your portfolio, and it's really so much easier than you think. With technology and with our help and our technique of doing the hybrid self management, you can remotely manage properties from 3,000 miles away. It's truly incredible how you can do this nowadays. Then you can really make the case, if it ever comes under question to the irs, that you are materially participating in the management of your properties. And this can be a big, big thing. So one more reason to get on that train. It's a, it's a really good way to go.

Yeah. So the 750 hours in real estate materially participate generally that's like involved in the day to day management of the properties. And the third one, the third one I think is the one that's probably, is for a lot of people to me, which is more time in real estate than your non real estate jobs. So somebody you know working at Google full time, 2000 hours, you have to have more than 2000 hours to be a real estate professional. And that's, I think that's the piece that's harder for those who are working full time. And, and that's where the planning comes in. You know, you might, maybe you have a spouse who's not working full time part time or you might be someone who maybe one year is taking leave, you know, to be at home with the kids. And that's a great opportunity to say, well, I'm not working this year or not doing full time this year. Can I then use Real Estate Professional to release all of my rental losses against W2 or other business income?

And that's, that's a great thing if you can do it. And you know, there are other little tips and tricks on this too. It's a long topic. Again, this is another one we could talk about for hours.

Another eight hours.

Yeah, exactly. Okay, Amanda, what else is up your sleeve? What else do you want to share with people?

You know, we just talked about the benefit of Real Estate Professional. And just to put some numbers to things, you know, we have clients who make $300,000 $500,000 of income if they have a spouse who can be a real estate professional. It is very possible to get to zero tax. I know for people it kind of sounds ridiculous, right? Like how do I get from 37% down to 0%? And that's with real estate and something that you mentioned, Jason, just the whole concept of leverage, right. Because we can take depreciation based on the purchase price, not just the down payment. And so the more leverage you're comfortable with in terms of building your portfolio, you can quickly scale up to very large tax benefits just from depreciation. But I also think, I don't want to discourage people who are not real estate professional. You know, maybe we have in our audience like two doctors and they're like, we're not going to stop working. You know, we spent too much time to learn how to be physicians. And so, so there is still benefit to investing in real estate because our goal is always to have our money work for us. And that's through investing, whether it's real estate or we Have a lot of clients who invest in other businesses, you know, doctors as an example, who invest in imaging centers or surger centers of their friends and other colleagues. And if those are kicking off some significant passive income, then your rental losses and depreciation and cost segregation can go a long ways to help offset the taxes from all those investments, too.

Sure can. They sure can. Exactly. Are there any other. I mean, there are smaller tax benefits that we can talk about, like just writing off expenses that might otherwise be personal expenses if you weren't in the real estate business. Okay. And that's the great thing. You know, most of our clients have corporate jobs or they own a business, and, you know, they're fully engaged in that. But this little side hustle in real estate could be your biggest wealth creator, believe it or not. It's just such a powerful asset class. There are a lot of, like, lesser benefits, like the ability to take a lot of these expenses and, you know, have them become deductible. Do you want to talk about any of that?

Yeah. And I think that's actually one of the most common tax mistakes that I see with respect to investors. People not understanding what they can write on off. Right. So, you know, like, maybe someone's on this podcast with us, like, okay, yeah, I didn't know that I could write off part of my car that I'm using because it's not held in an LLC or something. Right. So I think the one thing we. I want to make sure people are really clear on is when you have an expense, it doesn't have to be from an llc. It doesn't have to be paid for by an llc. You don't have to hold title of your rentals in an LLC or whole title to your car in an llc. IRS doesn't really care about that. They care about your ability to prove that the expense is. Is ordinary and necessary for your real estate activities. So I think people often confuse, like, business expense meaning LLC or corporation. That's not what it means. Business expense means I had this expense because of my real estate. And so most investors use their car for real estate. Most people work out of their home office. You know, I don't have very few clients who rent an office space just to manage their Florida or Ohio properties. It's almost unheard of. So just making sure you track those and then the. I think the best piece of advice I would give people is when you're spending money on something, especially things that are significant in dollar amount, ask yourself, is this something that would be necessary and ordinary to a real estate investor to help grow their business, improve their business. If so, keep track of it and then give it to your tax person. They will be the one to tell you yes or no, whether you can actually write it off. The problem is when you don't even track it and you don't ask yourself those questions. Your CPA doesn't even see that because they're not with you every day. So that's automatically something that you will miss out on a tax return.

Yeah, that's. That's really good advice, Amanda. Thank you for that. And I want to just tell you, this might be a little off color, so I'm going to warn everybody, but I heard this from my own CPA and it amazed me because what is considered ordinary and customary in the course of your business can have a pretty wide definition. And here's the example. This is a somewhat famous case. You probably know what I'm going to say, Amanda. So there was an exotic dance who took a deduction for an augmentation, and the IRS audited her and disallowed it. And she went to court and she won against the irs. So that became a deductible expense. So, you know.

Well, you're actually wrong, Jason. It was not a deductible expense.

What was?

It was. So the tax.

You know about the case, right?

Of course, of course. So the tax is probably every CPA's.

Water cooler case they talk about. It's funny.

So the tax court did allow the breast implant, but they didn't let her deduct it. They made her depreciate it, just like real estate. Because why? It has a useful life of 101 year.

That's even funnier. So what is the depreciation schedule on that?

I know. And can we do a cost segregation? I mean, I don't know if that was down today. Maybe we have, you know, 60 bonus depreciation.

I've got to know, what is the depreciation scale like? Do you know?

I mean, I don't know.

I. I mean, that's so funny, you know, that. That's amazing. Wow.

Yeah. And I think. And I think you're right, too. Just, you know, what is ordinary, necessary for one person may not be the same, you know, for another, for another investor. And so that's where the planning comes in. You know, I think a lot of times people will talk to their cpa, say, can I write off my kids? No, kids are not a deduction. But how can I write off my kids? Well, now, maybe they can help you out in your business, right? So. So it's really. And you know, I think by nature, CPAs are not very creative people, right? We as CPs are not creative. I put myself kind of in that same bucket. And so it's always good practice to ask the why question because it puts both you and your advisor in a more creative mode. Right? Can I do it? No. But how can I do it? Let's think about that. Let's try that.

Great. Amanda, that is such a fantastic tip. Instead of saying, can I do it, do it, Say, how can I do it? And that reframes your whole mind and reframes the focus and gets you on. There must be a way. So that example, let's just go through that again with the kids, right? Your kids are not deductible. I mean, there are deductions for child credits and so forth, but that's not what we're talking about. Okay? But if you hire your kids in your business, that expense to pay them can become deductible. So that's the how can I do it? Rather than. Than, can I do it? Because the can I do it? Answer is just going to be, no, you can't do it. But, yeah, how can you do it? There is actually a way. So very good advice. Very good advice.

You know, from a planning perspective, something that I personally realized by just talking to a lot of clients is that many CPAs, or most CPAs don't actually do planning. Right? I mean, CPAs file tax returns. And so in the off chance you actually have someone who does planning, what often ends up happening is. Is a Q and a session, you know, where you maybe heard about Jason's cost segregation strategies. You go to your CPA say, can I do a cost segregation? They tell you yes or no. You know, I heard about Real Estate professional, can I claim it? They'll say yes or no. But the reality is, the true planning is when your CPA is asking you the questions, you know, Jason, what's going on in real estate? What are you doing this year? What are you going to get rid of? Offload? How are you going to scale? And it's in those answers that Jason provides where the CPA will create strategies for you. Just like when you go to a doctor, right? You don't tell your doctor a set of questions like, hey, doc, do you think I have this? Should I take that medicine? Should I take these shots? No, it's them diagnosing you, asking you, how do you feel? What's going on and then they create like a, you know, a work plan for you in terms of curing the medical issue. So similar way to taxes, too.

Yeah, very good point. Very good point. Amanda, just one last thing, and I know we've got to wrap it up. Your advice and wisdom is so appreciated. Anything more generally not real estate related that you want to say to our listeners about taxes and saving on this life's largest expense, you know, doesn't have to be real estate related.

Yeah, I mean, I just think in general, take some time to do planning. You know, contrary to popular belief, when you meet with your tax person to file last year's returns, they are likely not helping you plan for the following year. So make that a dedicated separate meeting so that it's on the radar. I practice asking why because those are the things that we see missed all the time. You know, we talked a lot about real estate professional status and the kind of upcoming tax changes. One thing we are seeing and our industry, especially not just as CPAs, but real estate CPAs is an increase in audits. Now, it doesn't mean that we should shy away from the strategies. It just means that we want to make sure we have good documentation to support our positions. Right. So know the law. How do we document our car expenses? How do we document our real estate hours? Because if we're audited, and we talked about how significant some of these tax savings could be, if you're audited, you don't want to lose a case just because you didn't have sufficient documentation, you know, to hire help you. So take the time to do that and that way you feel safe in taking those major tax benefits.

Good advice again, Amanda, give out your website.

Yes, my company is called Keystone CPA and we have a lot of great free resources on there. We also have a tax risk assessment because I think that's one of the biggest questions people want to know. How do I know if I'm overpaying in taxes? So that's a helpful little tool@keystonecpa.com and I'm also all over social media as Amanda Hans, cpa.

You excellent. Amanda Han, thanks for joining us.

Thanks, Jason.

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