Subscribe
Share
Share
Embed
Hey there, fellow real estate investors, FIRE enthusiasts, and tax aficionados! Welcome to "Real Estate is Taxing" – your go-to weekly podcast for all things real estate taxes, hosted by Natalie Kolodij, EA- Real Estate Tax Strategist and dry humor extraordinaire.
Each week, we're breaking down complex tax topics into bite-sized, understandable explanations, with no regard for how many obscure references it takes to get there.
Speaker: Welcome to Real Estate is Taxing,
where we talk about all things real estate
tax and break down complex concepts into
understandable, entertaining tax topics.
My name is Natalie Kalady, I'm
your host, and I am so excited
that you've decided to join me.
Microphone (Shure MV7): Hello.
Hello everyone.
And welcome to today's episode.
I wanted to start off today by
poisoning a question for you guys.
So, whether you are listening as a real
estate investor or a tax professional.
There is a good chance that
you have attended one or more
conferences in your time.
I feel like right now
it is conference season.
Especially in the tax world.
Summertime is when we've got a little bit
of downtime and we can go to all of these
large conferences and small local events.
And get our CE hours and for the year.
So my question for you.
Is, why do you go to conferences?
Are you someone who does, do you attend
live conferences or do you tend to just
learn things through online offerings?
And when you go to a conference,
what is your main intention?
When you go.
I know that some people
will go to a conference.
Solely with the purpose of learning.
Their head down very focused and they're
only there to listen to the speakers.
And I know that there are other people who
will attend a conference largely for the
purpose of networking, making connections.
Or seeing people who they've known in
the industry for years, seeing friends.
And things like that.
So I am very curious why
you attend conferences.
And second part to this question.
When you go to a conference.
What are some of your best
tips or what are some things.
And that you put in place so that
you can easily remember everyone
you meet and make sure that you are
actually like making the best of it,
making the most out of that time.
You have with all of these
other people in your field.
The reason I.
I ask is I am going to a lot of
conferences this time of year.
And a few things that
I have put into place.
That have been super helpful for me.
And I think some of you might
get value from the first thing.
Is even though I hate them.
I bring business cards.
A lot of people still do
use them or ask for them.
And I try to have these
handy whenever I can.
Another thing that I prefer to do as well.
I will give someone my business card.
I would always rather
receive someone else's.
At the end of a conference, if someone
has spoken to 500 people and you're
just one of a stack of business cards.
There's a pretty slim chance.
They're even going to remember who you
are, let alone ever reach out to you or
move past that conference point of sharing
something useful for you or with you or.
Asking about collaborating on
something or whatever it might be.
When you're just one person in
a stack of cards, it's really
hard to set yourself apart.
So I would always rather be
the person receiving the cards.
I will take people's information.
And then after the event, I
will follow up with them in some
way, just so that we have that.
Secondary point of contact.
I'll send them an email and reference
something we had talked about, or I'll
add them on social media and follow
their business page or whatever it is.
I always want to be the person
doing that followup to make
sure it doesn't just get lost.
I think that happens a lot.
We go to these conferences and
a lot of the time they're a fair
amount of money to go to these.
And then we meet all of these
incredible people and then
we just lose the connection.
So my tip is to be the person
collecting the information.
And take the action to follow up,
even if it's something small, even if
it's just a quick email or a message
online, just, it was great meeting.
Hope you found that information you
were looking for on this code section.
If you do end up finding that
case, you were talking about.
Would love if you'd send me an email,
is there anything else I can do for you?
Just some kind of follow-up.
I had heard a podcast recently talking
about this and they were saying that
when they attend a conference, Every time
they collect someone's business card.
What they do is that they write a
little note on the card specifically
about something that they talked about
with this person or related to this
person, something to help them remember.
So I think this is a good idea.
But my first thoughts were most business
cards have a lot of text on them.
Some people don't even have business
cards anymore, early up digital ones.
So I'm trying to think of
a better way of doing that.
Because I would love a good way to
keep track and kind of remember those
little tidbits that I've talked to
everyone about, whether it is their
dog's name, where they're from, what
they're doing that summer, what kind
of tax they specialize in, what kind
of investments they buy, what kind of
properties they invest in, what states.
Any of those little notes, I
would love a quick, easy way.
To save with that person's information.
As I'm talking to people at a conference.
Now, I know I can do a notes
app or scan in their information
as a contact and add notes.
But if anyone else has a creative
way, they've been doing this or an
app that works really well for this.
I thought about maybe doing like a
quick video clip with each person
or a selfie or doing a voice record.
So it transcribes it, something like that.
But if there is a good solution out
there that you've already found.
I would love to hear about this.
So I want to hear all of your information
about conferences, why you go.
What you get out of them, what your
current process is, and if you have a
stellar solution, For keeping track of who
you've met and kind of just remembering
all those little details about people.
Let me know.
And so you can either shoot me an email.
That's just contact at C
R E tax, strategist.com.
Or join us in the Facebook group.
I will have links to both
groups down in the show notes.
There's a group for tax professionals
and a group for real estate investors.
Happened to the Facebook group, make
a post in there, or send me a message
on Facebook, Instagram, wherever.
And let me know.
Because I am trying to up my conference
game this year and really make the
most of all those connections with
all of the fabulous people I meet.
Microphone (Shure MV7)-1: All right.
All conference talk aside.
Today, we are going to cover a topic
that I've sort of touched on and it
comes up a lot because it is incredibly
popular in the real estate tax world.
And that is cost segregation studies.
So today we are going to cover
what a cost segregation study is.
Why someone would want to have one.
Kind of the expectations from one
ballparks on what they would cost
or what you can expect the outcomes
to be different types of studies.
And a few of the red flags
or things to just be cautious
about as you're doing these.
I will have a follow-up episode
on this soon with a little
more on the cautionary tales.
But today's episode, we're really just
going to focus on the meat and potatoes
of what makes up a cost segregation study.
So in a nutshell, A cost segregation
study is something that you can
have done on a piece of real
estate that is going to go through.
And separate out all of the various
components of that property.
As a starting point.
When you buy a piece of real estate,
you are often paying one price.
For everything.
So that is your building and your land.
But it goes farther.
On that land.
There's likely some land
improvements, some fencing,
some driveways and sidewalks.
And in that building, there are all
kinds of other components, there's
flooring and electrical fixtures and
appliances, and the different run
into connect appliances and things.
All of these different
components have a value.
And some of these components.
Are considered not structurally
adhered to the property.
And they can actually be listed.
At a correct shorter life.
So what we mean when we say that?
Is for any kind of asset you
use in a trade or business?
That's a rental.
You are able to depreciate that asset.
Meaning since it will give
value over countless years.
The tax code says you need to match
up the cost with that amount of years.
So for different asset types,
there's different preset
lives that you need to follow.
So for residential real estate,
that's 27 and a half year for
non-residential that's 39 year.
And then within that, there's
also, like I was saying several
shorter life categories.
So five, seven and 15 years
are the most common breakouts.
Five-year assets are going to be
things like non-permanent flooring and
appliances and furnishings in a property.
Seven year assets.
We don't see too much on rentals.
I believe a shed would be seven
years but there's not much else.
I typically see.
15 year is going to be
your land improvements.
So those, again, fencing,
some landscaping, driveways,
parking, lots, things like that.
Walkways.
Land improvements.
Another option for 15 year in some
real estate is going to be your
qualified improvement property.
So that is improvements done to the
internal part of a property that has
already been in service and it does
have to be non-residential property.
So that's another category
that is also under 15 years.
The reason we like separating
out these various components
with a cost segregation study.
Is that they take the depreciable
life of these assets from 39 years.
And can bring them down
to as low as five years.
So, if you are going to write off
the same $10,000 across 39 years
or five years, The amount you get
to write off per year will be much
higher if it's only across five years.
Now I'll get pushed back on this
and I've had tax professionals tell
me, Natalie, this isn't actually
creating any more deductions.
You're just, front-loading them.
You're taking more upfront instead of
spreading it out more across the 39 years.
And you are absolutely correct.
That is what we are doing.
You have the same amount
of asset value, either way.
We're not creating more or creating more.
Write-offs we're just choosing to take a
bigger chunk of them in those first years.
There's a few reasons for this.
For me, one of the biggest ones
is most real estate investors.
Don't hold property for its entire life.
Very often real estate
is not held for 39 years.
I think on average the whole
time is closer to seven years.
So if you're going to own a piece of
real estate and you have a purchase
price of X amount of dollars, and you
are allowed to depreciate and write
off all of that across reasonable
lives, as, you know, set out.
Would you rather get three
quarters of that purchase price
during the time you own it?
Or would you only rather get.
A third.
So basically the trade-off is you're not
going to own it for those later years.
So why are we saving deductions for a
time that you likely will never get to.
So that's my first reasoning for
looking at cost segregation studies.
Past that.
They're actually more accurate.
In many cases.
Building is not just a building.
So breaking things out is a more
appropriate way to depreciate them.
And then we have values
for when we replace assets.
So.
Normally.
If you replace the floors or offense,
or if you swap out any of these worn
out items in a piece of real estate.
If you listed the property
for just building and land.
When you dispose of the fence.
You don't know what the value of the
fence was as part of that building.
Like you don't know what its portion
of the cost was that you're now
taking off your assets schedule.
You don't have that amount.
So it.
Ends up with these skewed values
because we're adding a new fence.
But we didn't remove the deep portion
of the cost of the old fence where
we're adding new floors, but we didn't
remove the cost of the old floors.
So we end up just adding and adding and
adding to this original building cost.
But the building had most of these things.
As part of that original cost.
So it creates some inaccuracies
when we don't separate them out.
Additionally, not only do we
get to front-load a lot of these
depreciation write-offs that we
would normally not ever get to.
But anything with an asset life
of 20 years or less qualifies
for bonus depreciation.
Which is just a fancy way of
saying you can write off a big
chunk of it in that first year.
So for 2017, through 2022,
this was a hundred percent.
For 2023, it's 80 for 2024 at 60.
It's currently phasing out.
I don't think it'll disappear
fully, but only time will tell.
So in addition to getting to push all of
those expenses from years, you're likely
not even going to own the property.
Into those initial years,
when you do own the property.
Past that we then get to take a
big chunk of that front-loaded
expense in the very first year.
So this can be an incredibly
helpful tax planning tool.
To anyone who is able to use those losses.
If you are a real estate
professional and you can use them.
If your income is under a hundred
thousand dollars, so you can use
up to $25,000 a year of passive
losses against your other income.
Or if you have a large gain from real
estate during a specific year, if you're
selling a property for a large amount
of gain, Doing a cost segregation and
creating a large amount of loss on a
different property can offset that gain.
So there's a lot of planning opportunity
with cost segregation studies.
Because what we're doing is separating
out components into shorter lives.
And then we can take a big chunk of
that shorter life asset all at once.
So really cool planning opportunity.
Now more on the side of the actual.
What is a cost segregation study?
So there's a few different types of
studies and there are multiple ways.
There's six different ways
that a study can be conducted.
That are listed out in the cost
segregation audit technique guide.
Highly recommend you guys go and
download this and read through it.
Whether you are an investor
or a tax professional.
There is so much good information in this.
The IRS literally puts out
the guide to audit you.
Why would you not want to know that?
So in that guide, it lists out six
different ways for conducting a study.
And typically who does this
study will be a cost segregation
from some accounting firms.
Also do them in house.
But most common it's a third party firm.
So of those six ways.
The most common ways land around having
an engineer based study completed.
Where an actual engineer who is an expert.
On these topics on these
assets and their class lives.
They will either do a site inspection
where they come to the property or
they'll do a video walk through.
They're going to do an
actual hands-on analysis.
Of the asset of the, everything
it has as parts of it, what
their reasonable values would be.
It is a full in-depth study and
these tend to be a few thousand
dollars for residential real estate.
If you have a one to four
unit, I see these on average.
Between 1500 and $4,000.
On average, when you do one
of these engineered studies.
Of that initial building value.
I tend to see about 20 to 30% of that
can get pushed into those shorter lives.
So the engineered studies, these
full studies are the recommended.
That is what I recommend to.
Pretty much everyone.
They're going to be your
most reliable option.
They're the most in-depth
they're the most appropriate.
The next option.
Is a DIY study.
So there are websites.
That will allow you to just
type in the property is address.
The year it was purchased
the square footage.
If it has carpet or tile, like a pew, just
broad defining factors about the property.
And then they use.
An algorithm they're pretty
much using a software of data.
To assign reasonable values
to each of those components.
In that audit technique guide.
The very bottom of the list,
do list that there can be.
An allocation defined by a
sampling or modeling approach,
which is somewhat what this is.
The very last option is sort of a rule
of thumb approach, which is just looking
at I'm looking at other similar, like
properties in this industry, similar fast
food restaurants or similar hotel chains.
We tend to land at about these amounts.
So very vague.
Sampling is a little more detailed
where there's sort of a large sample
taken and then brought down into a
reasonable allocation based on the D.
The defining facts of that sample.
Either of these though, isn't
specific to your property.
It's generalizing.
So that's what these DIY studies do.
In reading kind of how they do this
on one of the websites for this.
What it says is that what
they are doing is that it uses
many of these same concepts.
But instead, the information is processed
using their proprietary algorithm.
And use to generate a logical breakdown.
So at DIY study.
Does not look at your specific property.
It does to a certain
extent, but very high level.
And to me, these are not, not reliable.
They're very bottom of the list.
They'll give you some amount of
breakout, but it, it could be
very, very, very hard to defend.
And many of these firms do have an audit
protection where if it is looked at,
they will back it with a full study.
At that point, but even then
be really cautious of these.
So there's a few methods.
To do a cost segregation study.
Like I said, what I recommend is
going to affirm and having an actual
full engineered study completed.
At the very start of this.
My recommendation is before the
information goes to that cost segregation
from you and your accountant, or
if you're the tax professional, you
should set up that starting basis.
Looking at closing costs, any additional
fees that went into it, all of that
create your initial starting basis and you
figure out the land and building value.
Some firms.
We'll use a standard split
for land versus building.
Like 85, 15, 80, 20, whatever it
is, they're going to use a standard.
And that's not a reasonable method.
To separate land and building.
So you want to give them that starting
point of the building is this much, the
first step in any segregation for any
rental is you start with the land value.
That's the first thing you're
supposed to separate out.
And the audit technique I'd
actually says to separate out
its highest and best value.
Meaning, if you have a few different
things that are giving you this
value, if you have an appraisal,
but also a county assessor value.
You're supposed to use, whatever one gives
the highest value to land, which is the
leaf least preferential to the taxpayer.
So if you are audited and they
find there's a higher land
value, that was reasonable.
That could be adjusted.
So as a starting point, you should
create the land and building value,
including closing costs and provide
this to the cost segregation firm.
Without this, they might
use a standard allocation.
And also most don't loop in closing
costs because different accountants
will treat them differently.
So then you have to be mindful of
that and you have to separately
account for those on their own.
The next thing.
That I would say to be
incredibly cautious of.
Is, if you are doing a cost segregation
study and you are doing this
intentionally to create large losses
using bonus depreciation, and you
have a way to use the loss that year.
This is all very intentional.
Make sure.
That there is not an
election on the tax return.
To elect out of special depreciation
or to elect out of bonus depreciation.
There is an election that
can be made under code 1 68.
K that says that for specific
asset class, the taxpayer is
not taking a special allowance.
They're not using bonus.
And I have seen this on returns before.
Just kind of mindlessly where they
do it as default, or they were
taught to do it that way, or they
just didn't know what it meant.
If you make this
election, it is permanent.
And what that now means is that even
with that study separating out those
five and seven and 15 year assets.
They'll be on those shorter lives.
But if that election is there, you
cannot use bonus depreciation and
you can never go back and fix it.
It's a permanent election.
Once you've said you're not doing it.
You can never do it on that asset.
So be cautious of that.
If you had a tax professional, do
your return double check for that.
If you're a tax professional.
Be leery of making this election, unless
there's a very intentional reason.
The next little warning.
I'll give you guys.
Is if you are doing.
A 10 31, like kind exchange.
And have plans to do a cost
segregation on that replacement asset.
There's another election you're
going to want to look at.
When you do a 10 31 exchange as a default.
What happens that's when
you sell a property.
That is used for investment
or business purposes.
You defer the gain by
investing in a new property.
The standard treatment after that is you
technically have two assets on your asset
schedule or your depreciation schedule.
The first one.
Is the asset you got rid of
that basically just stays there.
That same life, that same amount,
the carry over amount of basis.
Stays there.
So that'll be on one timeframe.
And then any excess basis or new basis.
So basically if you traded up.
So you put in an extra $200,000 into
the exchange, you bought a property
$200,000 more that new $200,000, the
value starts at that new acquisition
date across a new life, but you would
have two different assets running it.
Two different schedules that carried
over a mound stays on its own schedule.
Just as exactly what it
was before you sold it.
And then that new, extra value,
whatever you bought up into
starts on a new schedule.
That is the standard.
That is what should be on your
asset or depreciation schedule.
If no election has made.
However.
Under.
One.one 68.
I in the CFR.
There is another election here.
To elect out of that treatment
and instead to elect, to treat.
Both assets.
As one asset starting at
that new acquisition point.
So instead of having that prior
assets still listed there at like
year 10 out of 39, And a new asset
starting brand new at year zero.
For whatever your trade up value was,
it's all going to combine into one amount.
Starting over again at zero.
So that is your other option
is combined into one asset.
It's always worth looking at both to see
what is better in terms of a tax benefit.
But the way this comes into play
with a cost segregation study.
Is, if you are doing a
cost segregation study.
On a property that has been obtained
through a 10 31, like kind exchange.
Only that new excess basis.
Qualifies.
So in that earlier example, only
that 200,000 of trade up value.
Would the cost segregation study apply to.
Unless you make that election to
treat it as one asset, then it
applies to the carry over basis from
the old property and the new amount.
So that carry over basis was $500,000
and your trade up is only two.
If you don't make that election, you're
not getting to do a cost segregation
study on $700,000 worth of asset.
It would only be on the 200,000.
So be really cautious with this.
And talk to your tax professional and
to make sure that if there is a chance
that you are going to be doing a cost
segregation after your 10 31, That you
look at making this election to treat
everything as rolled into one new asset.
The last comment that I'll add
about cost segregation studies.
Is once you have separated out
all of these different assets.
Now what happens.
So if it is the very first
year asset is being listed.
It is the first tax return.
It hasn't been reported prior.
You just obtained the property.
Then you can just start off the
asset listing to the depreciation
listing with that breakout.
With all of those different assets.
If, however, this property has
been reported already for 10 years.
Five years, two years, whatever the
case is, if it is not the first year
and it has already been reported.
And you now are changing from one
overall value for a building to all
of these different broken out values.
Then most likely.
You will need to file form 31 15.
Which is for a change
of accounting method.
You're going to change the method.
From that building to all of these
different broken out shorter life assets.
31 15 is a pretty in depth form.
And it is required any time.
The depreciation is being changed
after more than one reporting year.
So, what that means is if you put the
rental in service, let's say right now
you would put it in service in 2023.
So it's listed on the 2023 tax return.
With that full amount
for a building value.
And in 2024, you do a
cost segregation study.
Since it has only been on one return.
It has not established.
A depreciation method yet two or more.
Define that method.
So since it's only been on
one year, you have the choice
to either go back and change.
2023 is return and amended.
And change to these broken out assets
or file the 31 15 with your 2024 return.
And then the change and any
net impact from that change,
all get reported on 2024.
So you have that choice.
If it's only been one year and you
can do whatever is preferential.
As soon as it's been two years
or more where it's been reported.
Your only option is that 31 15.
And you don't go backwards.
So this won't go back and amend and
change your tax for any of those earlier
years when you owned it, the rental.
The full amount of change happens
in the year you file the 31 15.
So in recap, That is the recount
on a cost segregation study.
we went through.
The two types of studies, there's a
full engineered study or a DIY study.
We do not want the DIY
studies steer clear of those.
An engineered study is what we
want, where someone will actually
look at your specific property.
The reasons we would want a cost
segregation study at a high level.
Are to separate out pieces of that 1
39 year or 27 and a half year asset.
Into a breakout of the shorter
life assets so we can deduct more.
During the time we own it.
Front-load those write-offs.
Double down on that, by being able
to apply bonus depreciation and
deduct a large amount all at once.
One more quick note on that.
The amount of bonus depreciation
is based on the year.
The asset went in service,
not when you do this study.
So if you're listening and you had real
estate, if you had rentals that you
put in service between 2017 and 2022.
Those can still get 100% bonus.
So in addition to
front-loading those expenses.
Taking that large amount of
write-off tax planning opportunities.
The other.
Really neat benefit of a cost segregation
study is now we have actual values.
For various components of property that
we're likely to replace at some point.
So if we knew a fence cost $20,000.
And we have depreciated
it across several years.
And now the value that remaining
value of that fence is 10 grand.
But we have to tear it
down to put up a new fence.
We know that we have $10,000 of
value left that we get to write
off and take off the schedule.
Cause we're replacing it
with a whole new fence.
So having that breakout allows
you to have more accurate record
keeping and potentially increase
your expenses because you get to
remove that existing carrying value.
So.
That is the recap and
cost segregation studies.
They're an incredibly useful tool.
They've become much more
popular in recent years.
So I do want you guys to be cautious
with the firm you use, what kind of
study they're doing and what the impacts
of this will be, be mindful of any
elections that can come into play with it.
And just look at the big
picture before diving into one.
there will be an episode coming up soon.
That will go a little more into the
cautionary parts of this and what to
be careful of and what to check for.
But for today, that was the overview
on cost segregation studies.
As always, I hope you
guys found this helpful.
Don't forget to reach out or come
into a Facebook group and let me
know your thoughts on conferences.
I'm still looking for the ways to best
maximize my time at conferences and how
to keep track of all of the amazing people
I meet and amazing things I learned.
So I want to hear your answers.
So reach out to me, links will be
down in the show notes and as always.
If you are finding value from the show.
If you've enjoyed these episodes,
please subscribe and leave a five
star wherever you listen to podcasts.
And if you've really found this
valuable, I would love if you would
just take a second to share an
episode with a colleague or friend.
That you think would also find value?
So, thanks for listening you guys.
I hope everyone has a great rest of their
week and I will talk to you next week.