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
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So, thanks for listening you guys.
I hope everyone has a great rest of their week and I will talk to you next week.