Episode 14: The Power of Cost Segregation and Bonus Depreciation

Welcome to Building Passive Income, the podcast for professionals, entrepreneurs and investors who want to build wealth, diversify beyond Wall street, and create true financial freedom through passive commercial real estate investing. I'm Wayne Courageous III, founding and managing principal of Crei Partners, a leading commercial real estate company. I created CreiColin, an AI powered resource to serve as your investor education guide. Built on the insights and experience we've developed at Crei Partners, CreiCollen is here to educate you through passive invest tax strategy topics to help your journey in passive investing. Just a quick disclaimer. This podcast and CRA Colin is for educational purposes only and is not legal tax or investment advice. Always consult with your attorney, CPA and financial advisor before making any investment decisions. I've spent nearly two decades helping investors understand the power of commercial real estate. From multifamily to storage to retail. Each episode is under 15 minutes, simple to follow and and packed with insights to help you grow your income and protect your capital without becoming a landlord. If you're ready to learn quickly and invest smarter, you're in the right place. Welcome to Building Passive Income. Let's build wealth together. Here's creicollen.

If you're a high income earner paying 35, 40, even 50% in taxes and you need to understand two cost segregation I'm Crei Collin and this is Building Passive Income where we give you the strategies to build real wealth through passive real estate investing. Today we're talking about one of the most powerful tax strategies in real cost segregation and bonus depreciation. These aren't just buzzwords, they're tools that can generate six figure tax deductions in year one of an investment, legally, strategically and with IRS approval. But here's the catch. Most investors don't understand how they work, when to use them, or how to maximize the benefit. So let's break it down before we dive into cost segregation. Let's start with the basics. Depreciation. When you invest in real estate, the IRS allows you to deduct the theoretical wear and tear on the building over time. This is called depreciation. For residential real estate like multifamily, the IRS says the building has a useful life of 27.5 years. So if you buy a building worth $10 million, you can deduct roughly $360,000 per year in depreciation. Here's the key. Depreciation is a non cash deduction. You didn't actually spend that money. The building didn't actually lose value. But the IRS lets you take the deduction Anyway, it's one of the most powerful tax benefits in real estate. Now. When you invest in a syndication, you don't own the entire building. You own a percentage based on your investment. So if you invest 100,000 into a $10 million deal, you own 1% of the building and you get 1% of the depreciation, roughly $3,600 per year. That's helpful, but it's not game changing. And that's where cost segregation comes in. Cost segregation is a tax strategy that accelerates depreciation. Instead of depreciating the entire building over 27.5 years, a cost segregation study breaks the property into components and reclassifies certain items so they can be depreciated faster. Here's how it A cost segregation engineer goes through the property and identifies components that can be reclassified as 5 year, 7 year or or 15 year property instead of 27.5 year property. For example, appliances, carpets and cabinets can be reclassified as 5 year property. Landscaping, parking lots and fencing can be reclassified as 15 year property. Lighting, flooring and H Vac components can be reclassified as 7 or 15 year property. Typically, a cost segregation study will reclassify 20 to 40% of the building's value into these shorter depreciation schedules. That means Instead of depreciating 360,000 per year, you might depreciate 1 million, 1.5 million, even 2 million in year one. And if you invested 100,000 into that deal, your share of the depreciation just went from 3,600 per year to 30,000, 40,000, maybe even 50,000 in year one. That's a paper loss you can use to offset passive income from other investments or in some cases, your W2 income if you qualify as a real estate professional. Now let's add bonus depreciation into the mix. Bonus depreciation is an IRS rule that allows you to accelerate depreciation even further by taking the full deduction in year one instead of spreading it over five, seven or 15 years. Here's how it works After a cost segregation study identifies components that can be depreciated over 5, 6, 7 or 15 years, bonus depreciation lets you take 100% of that depreciation in year one if the rules allow it. For example, let's say a cost Segregation study identifies $2 million worth of five and seven year property without bonus depreciation. You depreciate that over five to seven years. With bonus depreciation, you take the full 2 million in year one. Now here's the catch. Bonus depreciation is phasing out. Under current tax law, it was 100% through 2022. In 2023, it dropped to 80%. In 2024, it's 60%. In 2025, it's 40%. In 2026, it's 20%. And in 2027, it's gone unless Congress extends it. So if you're investing in 2025 and a deal does a cost segregation study that identifies 2 million in accelerated depreciation, you've get 40% bonus depreciation. That's 800,000 in year one. And the rest would be spread over the normal five, seven or 15 year schedules. Still powerful, but not as powerful as it was a few years ago. That's why timing matters. Let's walk through a real world example so you can see how this plays out. Let's say you invest $100,000 into a multi family syndication. The property is a $10 million acquisition. Your ownership is 1%. Without cost segregation, you'd receive roughly $3,600 in depreciation per year. That's your share of the building's 27.5 year depreciation schedule. Now the sponsor hires a cost segregation firm to do a study. The study identifies 30% of the property, $3 million as 5, 7 or 15 year property. The deal is acquired in 2025, so bonus depreciation is at 40%. Here's the 3 million in accelerated depreciation components. 40% bonus depreciation in year one. That's 1.2 million. Your 1% share. $12,000 in year one depreciation from bonus alone, plus your normal share of the remaining depreciation over time. So instead of 3,600 in depreciation, you might see 20,000 to 30,000 in year one. That's a passive loss you can use to offset passive income from other syndications, rental properties or other passive sources. If you don't have passive income this year, that loss carries forward indefinitely until you do or until you sell the investment, at which point it can offset your capital gain. So who benefits most from cost segregation and bonus depreciation? Let me break it down. First, high income W2 earners who also have passive income from other sources. If you're making 400,000 a year as a doctor, lawyer or executive, and you also have passive income from other syndications or rental properties, cost segregation can generate passive losses that offset that passive income. That's tax free cash flow. Second, real estate professionals, if you or your spouse qualifies As a real estate professional under IRS rules, more than 750 hours per year in real estate activities and more than half your working time, you can use passive losses to offset your active W2 income. This is huge, but it requires documentation and planning. Third, investors with significant passive income portfolios. If you're already invested in multiple syndications generating passive income, cost segregation on new deals can offset that income and keep your tax bill low. Who doesn't benefit as much? Investors with no passive income and no path to real estate professional status. You'll still get the depreciation and it'll still carry forward, but you won't see the immediate tax benefit. It's more of a long term strategy. Here's a strategy a lot of investors don't know about. Lookback cost segregation studies. Let's say you invested in a syndication three years ago and the sponsor didn't do a cost segregation study at the time. You can still do one now. It's called a lookback study. The IRS allows you to go back and reclassify components retroactively and you can claim the missed depreciation in the current year as a catch up deduction. You'll need to file an amended return or include it in your current year return with IRS Form 3115, but it's totally legal and IRS approved. This is especially powerful if you're in a high income year and you need to offset a big tax bill. Talk to your CPA about whether a lookback study makes sense for your situation. Here's the most important part. Cost segregation is a powerful tool, but it has to be used strategically. You can't just take massive depreciation deductions without understanding the rules, the limitations and the long term implications. This is why you need a real estate cpa. Someone who understands syndications, cost segregation, passive loss rules, and how to integrate this into your overall tax strategy. Before you invest in a deal with cost segregation, sit down with your CPA and ask do I have passive income to offset with these losses? If not, how will I use the carryforwards in future years? Does this fit into my long term tax strategy? Are there any depreciation recapture implications I need to understand? Your CPA should be able to walk you through the answers. If they can't, you need a different CPA. Go back and listen to episode 6 where TaxProteina breaks down how to find a Real estate CPA who specializes in this stuff. Alright, let's recap. Cost segregation and bonus depreciation are two of the most powerful tax strategies in real estate investing. Here's what you need to know. 1. Cost segregation accelerates depreciation by reclassifying building components into shorter depreciation schedules. 5, 7 or 15 years instead of 27.52. Bonus depreciation allows you to take the full deduction in year one instead of spreading it over multiple years. It's phasing out 60% in 2024 40% in 2025 20% in 20260 in 2027 3. High income earners with passive income Real estate professionals and investors with diversified passive portfolios benefit the most. 4. Look back. Cost segregation studies let you capture missed depreciation from prior years. 5. Work with a real estate CPA to integrate cost segregation into your overall tax strategy. Don't just chase deductions, build a plan. Here's your action step. If you're already invested in syndications, ask your sponsors, did you do a cost segregation study? If not, why not? And if you haven't invested yet, ask prospective sponsors, do you do cost segregation on your deals? How do you maximize tax benefits for your investors? Then take that information to your CPA and ask how do I use this in my tax strategy? And as always, consult with your CPA attorney and financial advisor before making any investment or tax decisions. This is education, not advice. If you're ready to start leveraging cost segregation and building a tax efficient passive income portfolio, let's talk. Check the show notes for a link to schedule a call with us@creipartners.com Next time on Building Passive Income, we're diving into Passive Loss carryforwards, your secret tax weapon for offsetting income for decades. Until then, remember, financial freedom isn't a dream, it's a decision. And it starts with keeping more of what you make. I'm Crei Collin. Let's build wealth together.

Thanks for tuning in to Building Passive Income. Today's episode helped shift your mindset or gave you a new tool to grow your wealth. Wealth. Do us a favor and like subscribe and share this podcast with someone you care about. Want to go deeper? Join our free Passive Investor coaching program@ passiveinvestorcoaching.com it's the perfect next step to start building wealth through commercial real estate the right way. Remember, financial freedom isn't a dream, it's a decision. And it starts with building passive income. We'll see you in the next episode. Sam.