WEBVTT NOTE This file was generated by Descript 00:00:08.209 --> 00:00:11.840 Speaker: Welcome to Real Estate is Taxing, where we talk about all things real estate 00:00:11.870 --> 00:00:16.869 tax and break down complex concepts into understandable, entertaining tax topics. 00:00:17.440 --> 00:00:21.259 My name is Natalie Kalady, I'm your host, and I am so excited 00:00:21.259 --> 00:00:22.670 that you've decided to join me. 00:00:23.748 --> 00:00:24.108 Microphone (Shure MV7): Hello. 00:00:24.108 --> 00:00:25.038 Hello everyone. 00:00:25.038 --> 00:00:27.108 Welcome to today's episode. 00:00:27.738 --> 00:00:33.108 If you didn't have a chance to listen to last week's episode on cost segregation. 00:00:33.468 --> 00:00:37.278 I would recommend circling back and giving that a listen first, because it's a little 00:00:37.278 --> 00:00:39.678 bit of a precursor to today's episode. 00:00:40.178 --> 00:00:45.128 What I want to chat with you guys about today is the, a word 00:00:45.308 --> 00:00:47.648 we're going to talk about audits. 00:00:48.248 --> 00:00:53.378 And anyone who knows me knows that I am not someone who fear mongers audits. 00:00:53.558 --> 00:00:55.958 There's a super low risk of audit. 00:00:56.228 --> 00:00:58.418 And if you're doing everything correct. 00:00:58.778 --> 00:01:00.998 There's really no huge impact. 00:01:01.028 --> 00:01:02.258 Just a little bit of time. 00:01:02.738 --> 00:01:06.008 So they're not the terrifying thing they're made out to be. 00:01:06.698 --> 00:01:08.948 But what we're going to do with today's episode. 00:01:09.368 --> 00:01:11.888 Is talk about a handful of things. 00:01:12.398 --> 00:01:13.478 That myself 00:01:13.598 --> 00:01:17.738 And colleagues I have who do audit representation have seen recently. 00:01:18.278 --> 00:01:20.048 Related to audits. 00:01:20.678 --> 00:01:22.598 In the real estate space. 00:01:23.318 --> 00:01:26.738 So the point of today's episode is not to scare you guys. 00:01:27.308 --> 00:01:32.348 The point of today is to go through and share what's going on 00:01:32.708 --> 00:01:34.898 and to give you proactive steps. 00:01:35.318 --> 00:01:38.708 So that you can avoid being in these same positions. 00:01:39.428 --> 00:01:43.358 A lot of the items that get pulled for audit. 00:01:43.808 --> 00:01:46.358 Are things that can be easily avoided. 00:01:46.718 --> 00:01:49.058 Or things you might not know you should be doing. 00:01:49.238 --> 00:01:53.288 So hopefully this episode lets you check a few of these things off your 00:01:53.288 --> 00:01:55.898 list and just puts you in a safer spot 00:01:56.398 --> 00:02:00.718 Microphone (Shure MV7)-1: The first item on the agenda is the mileage deduction. 00:02:01.348 --> 00:02:05.068 This is a really common item to get pulled for audit. 00:02:05.548 --> 00:02:09.118 'cause a lot of people do a really bad job at keeping these records. 00:02:09.778 --> 00:02:13.738 If you have a vehicle that you use for business and personal use. 00:02:14.458 --> 00:02:16.678 You need to keep track of your miles. 00:02:17.608 --> 00:02:19.798 Whether you are taking the standard. 00:02:20.098 --> 00:02:25.048 Cost per mile, which allows you to deduct a set amount per mile you drive, 00:02:25.498 --> 00:02:28.198 or if you are taking actual expenses. 00:02:28.528 --> 00:02:29.968 For either option. 00:02:30.028 --> 00:02:32.278 You need to keep track of how many miles you drove. 00:02:32.938 --> 00:02:37.018 So the first thing is you should be keeping a log of these miles. 00:02:37.558 --> 00:02:40.318 If you drive for business, you should be recording this. 00:02:40.828 --> 00:02:46.138 Either in a written ongoing log or using an app like mile IQ. 00:02:46.638 --> 00:02:47.538 The next thing. 00:02:48.138 --> 00:02:50.238 Is that you cannot count. 00:02:50.748 --> 00:02:51.858 Commuting miles. 00:02:52.758 --> 00:02:58.758 If you are driving from home to a place of business that is considered commuting, 00:02:58.998 --> 00:03:01.518 and those miles are never deductible. 00:03:02.118 --> 00:03:06.288 If you are going from business location to business location, like you were 00:03:06.288 --> 00:03:11.058 going from a rental property to home Depot and then over to another property. 00:03:11.688 --> 00:03:14.058 Those business miles would be deductible. 00:03:14.558 --> 00:03:16.748 The workaround to commuting miles. 00:03:17.168 --> 00:03:19.958 Is having a valid home office. 00:03:20.558 --> 00:03:25.388 If you have a qualified, dedicated space that you work from in your 00:03:25.388 --> 00:03:27.398 home related to your business. 00:03:27.848 --> 00:03:30.218 Then, if you are going from that location. 00:03:30.698 --> 00:03:31.628 To the property. 00:03:32.108 --> 00:03:35.648 That is now business mileage, because you're going business to business. 00:03:35.918 --> 00:03:37.418 It's technically not commuting. 00:03:37.868 --> 00:03:39.668 So that is the workaround there. 00:03:40.508 --> 00:03:42.098 Something, we are seeing. 00:03:42.638 --> 00:03:44.138 In more recent audits. 00:03:44.678 --> 00:03:47.408 Is that they're asking for more than just this log. 00:03:49.128 --> 00:03:53.778 So for example, If your log shows certain amounts of miles to a 00:03:53.778 --> 00:03:57.768 store or to a property or to any of these different places. 00:03:58.158 --> 00:04:02.388 If you also have a receipt from your purchase there with a timestamp and 00:04:02.388 --> 00:04:06.228 things like that, that can really show those check-in points, that's 00:04:06.228 --> 00:04:08.268 going to help substantiate your log. 00:04:08.768 --> 00:04:11.558 The other big tip for this section. 00:04:12.218 --> 00:04:14.078 At the beginning of each year. 00:04:14.378 --> 00:04:19.358 You should do something with your vehicle, that results in a third party, recording 00:04:19.358 --> 00:04:21.608 the amount of miles on your odometer. 00:04:22.328 --> 00:04:25.448 Whether this is renewing your registration, where you have to 00:04:25.448 --> 00:04:29.078 get an inspection or having a service done on your vehicle. 00:04:29.378 --> 00:04:34.358 What you want is just a formal piece of documentation. 00:04:34.988 --> 00:04:40.088 And even with some of the reports, they even will list to something like a Carfax 00:04:40.088 --> 00:04:46.298 report, something from a third party that shows how many miles are on the vehicle. 00:04:46.298 --> 00:04:47.408 January 1st. 00:04:47.828 --> 00:04:52.328 And if you do that every year, now you have this proof that during the 00:04:52.328 --> 00:04:55.508 year you actually drove 50,000 miles. 00:04:56.018 --> 00:04:58.208 So saying 20,000, our business. 00:04:58.628 --> 00:05:00.548 Isn't super unreasonable. 00:05:00.968 --> 00:05:02.618 If you didn't have that proof. 00:05:02.888 --> 00:05:05.648 And you said you drove that many business miles, which is 00:05:05.648 --> 00:05:07.238 more than most people drive. 00:05:07.658 --> 00:05:10.238 It becomes a harder burden to prove. 00:05:10.738 --> 00:05:13.948 Microphone (Shure MV7)-2: So the recap of action items for this section. 00:05:14.398 --> 00:05:18.598 Is that you are going to keep a log of the miles you have driven. 00:05:19.528 --> 00:05:24.388 Going to keep records of items that will substantiate those 00:05:24.388 --> 00:05:26.188 locations, such as receipts. 00:05:26.698 --> 00:05:29.728 And the last big tip that you are going to do. 00:05:30.268 --> 00:05:33.718 Is take your vehicle somewhere at the beginning of each year. 00:05:34.018 --> 00:05:36.778 To have a formal third-party record. 00:05:37.138 --> 00:05:40.348 Of how many miles are on the vehicle at that point? 00:05:40.848 --> 00:05:44.418 Microphone (Shure MV7)-1: The next item Is real estate professional status. 00:05:45.348 --> 00:05:47.478 This is something that comes up. 00:05:47.988 --> 00:05:49.938 All the time in court cases. 00:05:49.968 --> 00:05:51.588 I talk about these quite a bit. 00:05:52.248 --> 00:05:53.448 And what we're seeing. 00:05:53.988 --> 00:05:54.828 And rep work. 00:05:54.828 --> 00:05:59.118 I have a colleague who does a lot of representation for taxpayers with the IRS. 00:05:59.628 --> 00:06:04.128 And they are seeing an increased and audits related to real 00:06:04.128 --> 00:06:05.658 estate professional status. 00:06:06.378 --> 00:06:07.878 For a few different reasons. 00:06:08.378 --> 00:06:13.268 The first reason is people who in no way, shape or form qualify. 00:06:13.688 --> 00:06:15.728 These are people who work a full-time job. 00:06:15.758 --> 00:06:17.258 They've got one or two properties. 00:06:17.258 --> 00:06:21.038 There's just no universe where they're anywhere close to meeting the criteria. 00:06:21.458 --> 00:06:26.108 And they either don't know or don't care where we're just taking the gamble. 00:06:26.998 --> 00:06:30.164 Microphone (Shure MV7)-3: Whatever the reason for people in this situation. 00:06:30.554 --> 00:06:34.064 The proof doesn't come down to not having good records. 00:06:34.274 --> 00:06:37.424 It's just literally not qualifying to begin with. 00:06:38.024 --> 00:06:40.574 So the action step for this section. 00:06:40.994 --> 00:06:46.604 Is if you have a full-time W2 job, go ahead and assume that you 00:06:46.604 --> 00:06:51.134 can not qualify for real estate professional status at the same time. 00:06:51.824 --> 00:06:55.784 There's always unique circumstances, but out of all of the court cases 00:06:55.784 --> 00:06:58.784 on this, I believe there's only been one where it was allowed and it was 00:06:58.784 --> 00:07:01.394 a very obscure working situation. 00:07:01.904 --> 00:07:04.874 So typically, because you have to spend more time on real 00:07:04.874 --> 00:07:06.164 estate than anything else. 00:07:06.704 --> 00:07:08.894 If someone has a full-time job. 00:07:09.134 --> 00:07:11.774 It doesn't get very far in tax court. 00:07:12.734 --> 00:07:15.464 The next part with real estate professional status. 00:07:15.854 --> 00:07:20.114 Is people who do qualify, but have kept really bad records. 00:07:21.104 --> 00:07:23.984 If you are claiming real estate professional status, 00:07:24.104 --> 00:07:26.024 you have to claim your time. 00:07:26.444 --> 00:07:27.494 Your hour spent. 00:07:27.884 --> 00:07:29.594 On your real estate activities. 00:07:30.074 --> 00:07:34.154 You have to count your hours for material participation on your rental 00:07:34.154 --> 00:07:36.194 grouping or each rental activity. 00:07:36.644 --> 00:07:42.794 And if you have an additional job or business, You also need to track 00:07:42.794 --> 00:07:47.204 your time there because you need to prove that you spent more time on 00:07:47.204 --> 00:07:49.214 real estate than you did on that. 00:07:49.714 --> 00:07:51.334 So the first item here. 00:07:51.844 --> 00:07:56.284 Is make sure you are keeping good logs of these separate buckets of time. 00:07:56.764 --> 00:07:58.054 That detail out. 00:07:58.534 --> 00:08:02.554 Where you were, what you were doing the times you were doing it. 00:08:02.944 --> 00:08:07.354 And anything else that might be relevant and just add a little more context. 00:08:08.134 --> 00:08:11.284 If you are looking for a good way to keep track of this time. 00:08:11.704 --> 00:08:15.334 I do have a free real estate professional time log. 00:08:15.724 --> 00:08:17.734 That you can download from my website. 00:08:17.764 --> 00:08:20.284 If you just go to natalie.tax. 00:08:20.704 --> 00:08:22.504 And you can grab that free time log. 00:08:23.004 --> 00:08:25.134 While you're keeping track of your time. 00:08:25.764 --> 00:08:29.904 You want to be really mindful that what you're recording is accurate. 00:08:30.384 --> 00:08:33.894 Is not overinflated and that it makes sense. 00:08:34.914 --> 00:08:37.074 A common thread with tax court. 00:08:37.644 --> 00:08:43.404 Is if they have reason to believe part of your evidence is unreliable or 00:08:43.434 --> 00:08:46.404 can't really be used or isn't accurate. 00:08:46.824 --> 00:08:48.804 They now kind of doubt all of it. 00:08:49.614 --> 00:08:54.204 So if you have part of your hours that are inflated, or it's clear that you're 00:08:54.204 --> 00:08:56.934 really pushing to like make up time. 00:08:57.534 --> 00:09:01.674 If they see that now, even the valid hours, they're going to start to question. 00:09:02.174 --> 00:09:04.154 If you are looking for more context. 00:09:04.604 --> 00:09:06.824 On what time should be included in this. 00:09:07.274 --> 00:09:10.274 And how to set up your log and what they want to see. 00:09:10.784 --> 00:09:14.174 There is a passive activity, audit technique guide. 00:09:14.624 --> 00:09:16.844 And again, I'm a big fan of these. 00:09:16.844 --> 00:09:21.644 The IRS is literally saying here's the guide to how we're going to audit you. 00:09:22.064 --> 00:09:23.654 Why wouldn't you look at that? 00:09:24.134 --> 00:09:26.114 So check that out. 00:09:26.384 --> 00:09:27.974 Look over their examples. 00:09:28.034 --> 00:09:31.214 They even have lists of questions for the auditor to ask. 00:09:31.544 --> 00:09:35.114 Things that they're going to use to try to poke holes in your story. 00:09:35.324 --> 00:09:39.614 See, if you don't actually qualify, kind of catch these specific things 00:09:39.614 --> 00:09:44.204 that are often that string, that they can pull to unravel the entire 00:09:44.204 --> 00:09:46.394 claim that you would qualify. 00:09:47.324 --> 00:09:51.554 Currently that audit log isn't listed on the website. 00:09:51.914 --> 00:09:54.704 They are in the process of updating it. 00:09:55.034 --> 00:09:58.214 So it should be listed again soon, once they finish. 00:09:58.264 --> 00:09:59.074 Revamping it. 00:09:59.404 --> 00:10:00.844 So keep an eye out for that. 00:10:00.904 --> 00:10:04.294 And once it's back, download it, familiarize yourself with it. 00:10:04.864 --> 00:10:08.794 And make sure that if you are claiming real estate professional status, 00:10:09.154 --> 00:10:12.724 the way you are tracking your hours and what hours you are counting. 00:10:13.234 --> 00:10:15.514 Align with what you are allowed to do. 00:10:15.844 --> 00:10:17.524 Per that audit technique guide. 00:10:18.024 --> 00:10:21.084 Microphone (Shure MV7)-4: And the last area we are going to touch on today. 00:10:21.504 --> 00:10:23.514 Is cost segregation. 00:10:23.814 --> 00:10:25.614 This is where it all ties together. 00:10:26.334 --> 00:10:30.984 So this has come up pretty frequently lately from a few different sources. 00:10:30.984 --> 00:10:32.784 And there's a few reasons why. 00:10:33.324 --> 00:10:37.014 The first thing is just overall, the number of cost 00:10:37.014 --> 00:10:39.114 segregation reports has gone up. 00:10:39.594 --> 00:10:45.474 And these large amounts being written off has gone up because cost segregation 00:10:45.474 --> 00:10:47.394 has become much more affordable. 00:10:47.814 --> 00:10:50.334 Over the last few years than it used to be. 00:10:50.904 --> 00:10:55.344 In addition to that between 2017 and 2022. 00:10:55.824 --> 00:10:58.884 We had 100% bonus depreciation. 00:10:59.454 --> 00:11:02.934 Which was a huge incentive for getting a cost segregation 00:11:02.984 --> 00:11:04.544 So that's the first reason. 00:11:05.044 --> 00:11:10.114 The second reason is we've all heard about how the IRS has 00:11:10.114 --> 00:11:12.334 been hiring tons of new people. 00:11:12.334 --> 00:11:14.074 They got all of this funding. 00:11:14.614 --> 00:11:18.574 As a starting point, I'm not mad about it and you shouldn't be either. 00:11:18.964 --> 00:11:24.094 If you remember during COVID where if you filed anything by paper. 00:11:24.574 --> 00:11:26.644 It might just now be getting processed. 00:11:27.184 --> 00:11:29.224 They were wildly understaffed. 00:11:29.584 --> 00:11:33.394 We would try to call for clients and literally could not get a human. 00:11:33.394 --> 00:11:34.414 It was impossible. 00:11:34.414 --> 00:11:37.114 They would just be like, sorry, there's too many phone 00:11:37.114 --> 00:11:38.494 calls, I guess, deal with it. 00:11:38.914 --> 00:11:43.954 While simultaneously having the automated system continue to send notices. 00:11:44.404 --> 00:11:45.754 So that was a really fun time. 00:11:45.754 --> 00:11:48.374 I'm glad we got to go on that journey together. 00:11:48.914 --> 00:11:53.834 But I am pretty glad that they do have a little bit of staffing now. 00:11:54.794 --> 00:11:57.554 The downside is part of that staffing. 00:11:57.974 --> 00:12:01.124 Is people who are going to work in audit. 00:12:01.724 --> 00:12:04.064 So there's a little bit of a trade off. 00:12:04.544 --> 00:12:06.974 That being said, I'll reiterate this again. 00:12:07.004 --> 00:12:10.034 The point of the episode isn't to scare you guys, audit 00:12:10.034 --> 00:12:12.164 risk is still incredibly low. 00:12:12.584 --> 00:12:17.504 The point is just to take these proactive steps, to avoid the common 00:12:17.504 --> 00:12:19.514 things that are easy to get dinged for. 00:12:20.084 --> 00:12:20.714 In an audit. 00:12:21.434 --> 00:12:26.204 So as part of that hiring process, Where the IRS was getting 00:12:26.204 --> 00:12:28.664 to bring on more employees. 00:12:29.444 --> 00:12:31.214 Part of that was more engineers. 00:12:31.994 --> 00:12:36.374 Historically, they didn't have a ton of engineers on staff, which are the experts 00:12:36.494 --> 00:12:38.744 who would do cost segregation studies, 00:12:38.794 --> 00:12:43.834 Or who could analyze a study that was done by a taxpayer and say, if 00:12:43.834 --> 00:12:45.944 it was reasonable, under audit. 00:12:46.364 --> 00:12:50.054 The IRS did not have a ton of these qualified employees. 00:12:50.654 --> 00:12:53.924 So historically the ones they did have, they would spend. 00:12:54.374 --> 00:12:58.304 Their time on larger projects on conservation easements, cell phone 00:12:58.304 --> 00:13:01.934 easements, things that if under audit, they found things they could 00:13:01.934 --> 00:13:04.424 disallow would result in a greater. 00:13:04.844 --> 00:13:06.044 Collection of tax. 00:13:06.374 --> 00:13:08.954 So they were just going where their highest and best use was. 00:13:09.464 --> 00:13:12.404 As part of this hiring process, they're bringing on a few hundred 00:13:12.404 --> 00:13:16.214 more engineers and they're about two thirds through that hiring. 00:13:16.614 --> 00:13:22.374 So just over the past couple of years, The number of qualified people who are at the 00:13:22.374 --> 00:13:24.804 IRS to look at cost segregation studies. 00:13:25.164 --> 00:13:26.124 Has increased. 00:13:26.694 --> 00:13:31.074 So those are the two biggest reasons for seeing this increase in these audits. 00:13:31.434 --> 00:13:32.964 Even though it's still not many. 00:13:33.204 --> 00:13:35.514 They just used to be so, so low. 00:13:35.814 --> 00:13:38.964 What I heard from a larger firm was that where they'd see one 00:13:38.964 --> 00:13:40.674 a year related to real estate. 00:13:40.674 --> 00:13:42.084 Now they're seeing three. 00:13:42.744 --> 00:13:45.324 And this is a firm with thousands of clients. 00:13:45.714 --> 00:13:47.544 So it's still not a huge risk. 00:13:48.024 --> 00:13:49.224 You just want to be aware. 00:13:50.224 --> 00:13:53.284 Microphone (Shure MV7)-7: The final part of this episode is going to be 00:13:53.284 --> 00:13:57.784 what we're seeing related to these audits on cost segregation studies. 00:13:58.324 --> 00:14:02.644 And what you can do to avoid hitting these targets. 00:14:03.304 --> 00:14:06.244 The first item is those DIY costs eggs. 00:14:06.694 --> 00:14:09.214 Where you enter your own information online and an 00:14:09.244 --> 00:14:11.464 algorithm creates a report for you. 00:14:12.364 --> 00:14:18.364 If at all possible, you want to get an actual engineered cost segregation report. 00:14:18.934 --> 00:14:22.864 They're going to cost a little bit more, but they're going to be more reliable. 00:14:22.924 --> 00:14:28.204 And in my experience that often results in a bigger write off anyway. 00:14:28.594 --> 00:14:31.744 So rather than taking the risk, I would recommend getting 00:14:31.744 --> 00:14:33.484 the full study to begin with. 00:14:33.984 --> 00:14:35.844 Once you have a full study. 00:14:36.414 --> 00:14:41.874 Be mindful that not all firms are created equal and even the better firms out 00:14:41.874 --> 00:14:46.914 there can make mistakes or do things that might not be so buttoned up under audit. 00:14:48.294 --> 00:14:50.364 Microphone (Shure MV7)-8: The next pieces of information. 00:14:50.904 --> 00:14:55.404 R what I've put together after getting to review. 00:14:55.914 --> 00:14:57.084 An audit report. 00:14:57.384 --> 00:15:01.074 From a colleague who just had a client audited for two of 00:15:01.074 --> 00:15:02.724 their cost segregation studies. 00:15:03.174 --> 00:15:06.384 So I had an opportunity to look over that redacted report. 00:15:06.684 --> 00:15:12.414 And here are a few of the common themes and items that to me were the stand out. 00:15:12.774 --> 00:15:16.974 Red flags the first thing was that at a starting point, this 00:15:16.974 --> 00:15:19.434 client had left off income. 00:15:19.914 --> 00:15:21.444 On a couple of the years. 00:15:22.014 --> 00:15:28.584 So again, that same theme where if the IRS has reason to believe you're unreliable 00:15:28.584 --> 00:15:30.834 or they can't count on your information. 00:15:31.284 --> 00:15:33.354 They're going to continue with that mindset. 00:15:33.744 --> 00:15:37.464 So that was the first thing was just, they started off inaccurate. 00:15:37.964 --> 00:15:43.124 The next thing that the taxpayer was dinged for was land and building value. 00:15:43.364 --> 00:15:45.374 Talked about this a few episodes ago. 00:15:45.854 --> 00:15:52.964 They had two studies done by different firms, but both used a standard 85, 15 for 00:15:52.964 --> 00:15:55.514 building and land versus an actual value. 00:15:56.024 --> 00:16:00.194 So when the auditor saw this, they said that is not a reasonable method. 00:16:00.584 --> 00:16:02.624 And that was another ding against them. 00:16:02.624 --> 00:16:06.644 Or the auditor could now go in and readjust their land value. 00:16:07.144 --> 00:16:08.494 The third item. 00:16:08.854 --> 00:16:12.544 That was a picking point for the auditor. 00:16:13.114 --> 00:16:17.164 Was some of the amounts from the allocations into those shorter life 00:16:17.224 --> 00:16:19.384 assets, just weren't reasonable. 00:16:19.884 --> 00:16:22.944 There was a circumstance where on one of the properties. 00:16:23.334 --> 00:16:29.004 There was a single asset, something like a fence or driveway, one single thing. 00:16:29.664 --> 00:16:34.944 That was like 30% of all of the building and improvement value. 00:16:35.604 --> 00:16:39.084 So your action point here is when you get this report, even 00:16:39.084 --> 00:16:40.674 though you are not an expert. 00:16:41.124 --> 00:16:44.874 You should still look at it because you know what your property has 00:16:45.144 --> 00:16:46.734 and what would be reasonable. 00:16:47.364 --> 00:16:51.744 If you get this report back and they list half of the value of what 00:16:51.744 --> 00:16:55.974 you paid as the fencing, but you know, this property only has a small 00:16:55.974 --> 00:16:57.924 picket fence around part of the yard. 00:16:58.374 --> 00:17:00.714 Red flag, ask more questions. 00:17:00.744 --> 00:17:05.574 So just look over the reports for what seems reasonable based on what you do now. 00:17:05.964 --> 00:17:09.474 And ask questions if you're not sure you don't need to know all of the 00:17:09.474 --> 00:17:11.904 technical, just kind of common sense. 00:17:12.404 --> 00:17:13.544 The next thing. 00:17:14.024 --> 00:17:20.474 was lack of detail on additional items added to the depreciation schedule. 00:17:21.054 --> 00:17:23.094 This is something I see really often. 00:17:23.544 --> 00:17:28.044 Where we just receive one lump sum for something titled renovations 00:17:28.044 --> 00:17:31.044 or improvements or kitchen remodel. 00:17:31.074 --> 00:17:33.204 And it's just one price for everything. 00:17:33.204 --> 00:17:34.074 One cost. 00:17:34.794 --> 00:17:38.664 And so they were dinged for not having more detail on what those 00:17:38.664 --> 00:17:42.774 were, what the assets were that were included in this $20,000 item. 00:17:43.344 --> 00:17:47.874 So when you are doing a renovation, You want to break out as much as 00:17:47.874 --> 00:17:50.664 possible about those renovation details? 00:17:51.024 --> 00:17:52.854 To give to your tax professional. 00:17:53.424 --> 00:17:58.554 What I mean is if you are doing a kitchen remodel, don't just say $30,000 kitchen. 00:17:59.034 --> 00:18:02.454 You are going to break out appliances and you were going to 00:18:02.454 --> 00:18:07.794 break out farther refrigerator, $1,200 stove, $800 listed all out. 00:18:08.514 --> 00:18:10.404 For cabinets and countertops. 00:18:10.734 --> 00:18:13.254 You're going to list that out for flooring. 00:18:13.494 --> 00:18:16.464 You're always going to note what type of flooring. 00:18:16.884 --> 00:18:20.814 What value of each type of flooring you put into a property. 00:18:21.294 --> 00:18:23.514 So if it's all flooring that is hardwood. 00:18:23.964 --> 00:18:25.344 One price for all the hardwood. 00:18:25.854 --> 00:18:29.064 If the property has some carpet, some hardwoods, some tile. 00:18:29.424 --> 00:18:33.564 You'll want an amount for each of those because different flooring can 00:18:33.564 --> 00:18:35.394 have a different depreciable life. 00:18:35.724 --> 00:18:37.884 Depending on if it's permanently a fixed or not. 00:18:38.454 --> 00:18:42.024 And if your tax professional doesn't know that your 10 grand a flooring 00:18:42.054 --> 00:18:43.644 has actually three different types. 00:18:44.064 --> 00:18:47.184 Than if you're audited, you don't have the correct detail. 00:18:47.514 --> 00:18:49.944 So always break out that detail. 00:18:50.934 --> 00:18:55.224 The last thing that came up as part of this audit and has actually 00:18:55.224 --> 00:18:58.734 come up in conjunction with a prominent court case on this that 00:18:58.734 --> 00:19:00.024 I'm going to touch on real quick. 00:19:00.624 --> 00:19:02.574 His kitchen fixtures. 00:19:02.994 --> 00:19:03.144 All right. 00:19:03.174 --> 00:19:05.724 So your kitchen cabinets, countertops and sinks. 00:19:06.414 --> 00:19:08.994 These were always a more aggressive item. 00:19:09.414 --> 00:19:12.264 They started related to commercial kitchens. 00:19:12.294 --> 00:19:16.884 So the concept was if your rental property was now a business asset, 00:19:17.064 --> 00:19:19.554 similar strategy should apply here. 00:19:20.484 --> 00:19:22.734 But bathrooms are specifically excluded. 00:19:22.824 --> 00:19:26.994 So bathroom counters and sayings and cabinets, that's not allowed. 00:19:27.474 --> 00:19:30.864 Kitchens were allowed based on this commercial use definition. 00:19:31.704 --> 00:19:36.414 Dan still kind of a unique crossover, cause we're still in a single family house 00:19:36.414 --> 00:19:38.184 or an apartment, not like a restaurant. 00:19:38.994 --> 00:19:41.244 So this has always been something. 00:19:41.724 --> 00:19:44.424 That could be one of those strings that an auditor pulls on. 00:19:45.114 --> 00:19:46.404 So the advice here. 00:19:46.794 --> 00:19:50.184 Is that if your return is already more aggressive from 00:19:50.214 --> 00:19:51.834 other strategies you're using. 00:19:52.254 --> 00:19:54.264 Or if you are very risk adverse. 00:19:54.654 --> 00:19:57.564 If you do a cost segregation or you do a renovation. 00:19:58.014 --> 00:20:01.614 Don't separate out those kitchen components into five-year lives. 00:20:01.914 --> 00:20:06.234 Go ahead and leave them on that full life of 27 and a half years or 39. 00:20:06.234 --> 00:20:07.044 If it's commercial. 00:20:07.404 --> 00:20:08.604 Don't separate these out. 00:20:08.604 --> 00:20:11.724 they're low hanging fruit for the auditor to grab. 00:20:12.724 --> 00:20:15.424 Microphone (Shure MV7)-10: And the final connection on why all of 00:20:15.424 --> 00:20:20.194 these breakouts of assets matter and figuring out different flooring 00:20:20.194 --> 00:20:21.844 types and all of these things. 00:20:22.354 --> 00:20:26.524 It's because whether something is permanently affixed to the property 00:20:26.584 --> 00:20:28.714 and structural and a key component. 00:20:29.194 --> 00:20:33.904 Or if it is somewhat tangentially attached and is something that can be 00:20:33.904 --> 00:20:39.634 replaced and separated, this is what determines the useful life of that thing. 00:20:40.234 --> 00:20:43.534 So there are several factors called the Co-factors. 00:20:43.894 --> 00:20:45.814 That are what make this determination. 00:20:46.204 --> 00:20:50.014 And these look at how easily something is to be moved, how much damage it 00:20:50.014 --> 00:20:51.814 would cause how much time it would take. 00:20:52.174 --> 00:20:57.214 How often just looking at like common industry expectations, how 00:20:57.214 --> 00:20:59.884 often would this item be replaced? 00:21:00.184 --> 00:21:03.064 So all of these things are looked at in conjunction. 00:21:03.814 --> 00:21:07.684 To determine if something is permanently affixed, in which case it would stay 00:21:07.684 --> 00:21:12.844 on that 27 or 39 year life, or if it's not, and it could be removed and would 00:21:12.844 --> 00:21:16.444 be, or could be pretty frequently without too much damage or cost. 00:21:16.834 --> 00:21:22.504 So an example of this would be tile floors versus floating LVP, right? 00:21:22.894 --> 00:21:26.914 Tile, you can't really just pop it out and swap it out without doing damage to the 00:21:26.914 --> 00:21:28.594 flooring underneath it's a whole project. 00:21:28.594 --> 00:21:30.364 It is pretty permanently attached. 00:21:30.934 --> 00:21:32.914 Floating LVP is a different story. 00:21:33.214 --> 00:21:37.474 Not nailed down, not mortared down, it's a whole different circumstance. 00:21:37.774 --> 00:21:39.424 So that's really what they're looking at. 00:21:39.484 --> 00:21:43.594 And those factors are what you should look at when you're being mindful of this. 00:21:44.044 --> 00:21:46.834 And you can find them in that audit technique guide. 00:21:47.644 --> 00:21:48.934 These factors. 00:21:49.354 --> 00:21:52.504 Also reference back to a prominent court case. 00:21:52.864 --> 00:21:57.664 That was referenced in that audit report that we just talked about, 00:21:57.694 --> 00:22:01.864 but comes up pretty often in conjunction with cost segregation. 00:22:02.284 --> 00:22:06.334 So this is the America south case, and this was back from 2012. 00:22:06.844 --> 00:22:11.794 But basically the ruling on this case was that a cost segregation on an 00:22:11.794 --> 00:22:14.434 apartment building wasn't allowed. 00:22:15.364 --> 00:22:16.534 They looked at. 00:22:16.924 --> 00:22:20.614 The parts of the apartment as what would be required for it 00:22:20.614 --> 00:22:21.994 to operate as an apartment. 00:22:22.834 --> 00:22:27.514 Versus kind of the historical stance of there being an overall building and what 00:22:27.514 --> 00:22:32.044 was needed for the building to operate and then separate components within it. 00:22:32.944 --> 00:22:34.954 So this case kind of went against. 00:22:35.494 --> 00:22:39.064 All prior guidance for the most part, it was a whole different mindset. 00:22:39.694 --> 00:22:43.354 This auditor really went in on this and it was a multitude 00:22:43.354 --> 00:22:45.244 of problems with this case. 00:22:45.844 --> 00:22:50.314 The first one, being that the original cost segregation report 00:22:50.314 --> 00:22:52.174 that they had done kind of sucked. 00:22:52.384 --> 00:22:53.584 Wasn't a good report. 00:22:53.974 --> 00:22:55.234 It was inaccurate. 00:22:55.564 --> 00:23:00.604 They claimed things that weren't reasonable and they even pulled in 00:23:00.604 --> 00:23:07.004 things like costs for utility lines and electric lines that weren't the taxpayers 00:23:07.004 --> 00:23:08.804 that weren't part of their property. 00:23:09.224 --> 00:23:11.564 So the overall quality of the report. 00:23:11.804 --> 00:23:13.514 Wasn't good to start with. 00:23:13.964 --> 00:23:17.264 And this property was larger apartments. 00:23:17.264 --> 00:23:20.564 So they had paid $10 million for this apartment complex. 00:23:20.614 --> 00:23:22.984 So this was almost 400 apartments. 00:23:23.074 --> 00:23:24.934 This wasn't like a small study. 00:23:25.474 --> 00:23:27.694 So that study moved. 00:23:28.324 --> 00:23:33.004 Three and a half million dollars worth of assets into those shorter life assets. 00:23:33.344 --> 00:23:35.774 And these were five and 15 year assets. 00:23:36.434 --> 00:23:38.504 The auditor disagreed with this. 00:23:38.954 --> 00:23:39.554 And. 00:23:40.054 --> 00:23:42.784 Said they were disallowing it, they went through and they said most of 00:23:42.784 --> 00:23:46.864 these assets didn't qualify and they didn't agree with the allocation. 00:23:47.404 --> 00:23:51.364 So the tax payer filed a petition to challenge this. 00:23:52.084 --> 00:23:57.004 But the problem was then the taxpayer kind of S stopped participating. 00:23:57.674 --> 00:23:59.444 They didn't send in any evidence. 00:23:59.834 --> 00:24:02.714 They didn't go forward with any of their argument. 00:24:02.984 --> 00:24:07.454 So they kind of just dropped off and then they just dropped discussion. 00:24:08.054 --> 00:24:12.704 With both the IRS auditor and also their legal counsel on this. 00:24:13.424 --> 00:24:15.374 So it's a really unique case. 00:24:15.854 --> 00:24:20.954 Because it just didn't actually go through the way a case should've happened. 00:24:21.644 --> 00:24:25.784 And then the court went ahead and ruled, even though there wasn't. 00:24:26.144 --> 00:24:28.514 Any further evidence provided by the taxpayer. 00:24:28.904 --> 00:24:30.194 They didn't have to do this. 00:24:30.194 --> 00:24:33.754 They could have dismissed the case But they didn't, they went ahead and ruled 00:24:33.754 --> 00:24:35.554 and said they agreed with the IRS. 00:24:36.064 --> 00:24:40.264 And that you couldn't do a cost segregation report on apartments. 00:24:41.264 --> 00:24:43.844 Microphone (Shure MV7)-11: So the big problem with this America south case. 00:24:44.714 --> 00:24:45.374 Is that. 00:24:45.704 --> 00:24:49.484 It is something auditors can now basically hang their hat on. 00:24:49.874 --> 00:24:54.434 So if you have a cost segregation study done, and there is any amount of 00:24:54.434 --> 00:24:59.294 messiness to it, there's any string, they can pull to unravel it a little bit. 00:24:59.684 --> 00:25:03.404 They are basically coming in and just straight up saying Amera, 00:25:03.404 --> 00:25:05.774 south bitch and disallowing it. 00:25:06.134 --> 00:25:07.754 That is their Trump card. 00:25:07.754 --> 00:25:12.014 They're just throwing that down on the table and using that overlying 00:25:12.014 --> 00:25:14.144 guidance, just this one court case. 00:25:14.504 --> 00:25:18.254 So the final takeaway, the final action item for this episode. 00:25:18.674 --> 00:25:19.214 Is. 00:25:20.054 --> 00:25:21.614 Don't be terrified about it. 00:25:21.794 --> 00:25:23.594 Don't not do cost segregation. 00:25:24.314 --> 00:25:28.364 Just make sure that if you are doing it, that you're using a 00:25:28.364 --> 00:25:32.294 good firm, you're separating out your land and building value. 00:25:32.684 --> 00:25:37.934 You are doing all of these things that are easy to get dinged for so that 00:25:37.934 --> 00:25:42.104 an auditor doesn't come in and throw down that America south card on you. 00:25:42.674 --> 00:25:46.484 And just create a whole headache related to your taxes. 00:25:47.024 --> 00:25:49.844 So that's what I've got for you guys today. 00:25:50.234 --> 00:25:51.674 I hope you found it valuable. 00:25:51.674 --> 00:25:53.234 I hope you're not terrified. 00:25:53.264 --> 00:25:57.614 I hope you go read this audit technique guide and I hope you read through 00:25:57.614 --> 00:26:00.164 that America south case or some. 00:26:00.564 --> 00:26:01.614 Reviews on it. 00:26:01.614 --> 00:26:03.714 Some interpretations of it. 00:26:04.404 --> 00:26:07.824 Cause it's incredibly valuable to know if you are a tax professional 00:26:08.184 --> 00:26:12.054 or a taxpayer who might do or be involved with a cost segregation. 00:26:12.534 --> 00:26:15.624 You want to know what auditors are going to look for and you want to avoid the 00:26:15.624 --> 00:26:18.384 low hanging targets for being audited. 00:26:18.894 --> 00:26:23.994 So as always, if you guys have enjoyed this episode, please subscribe, 00:26:24.024 --> 00:26:28.494 share it, leave a review, and don't forget to join us in the Facebook 00:26:28.494 --> 00:26:30.204 groups linked in the show notes. 00:26:30.294 --> 00:26:33.204 And if you want that real estate professional time log. 00:26:33.474 --> 00:26:37.704 Just hop on the website@natalie.tax and you can download it there. 00:26:38.484 --> 00:26:41.964 I hope everyone has a fantastic rest of their week. 00:26:42.114 --> 00:26:44.364 And I will chat with you guys next week.