Real Estate Is Taxing

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)-2: Hello.

Hello everyone.

Today's show is a perfect example.

Of why the most common response
when it comes to anything

tax related is it depends.

If you are ever told something
with 100% certainty, that

could be different depending on
someone's specific circumstances.

That should be a red flag to you.

Unfortunately, this happens
way more often than it's shit.

And it can lead to people making the
wrong choice when it comes to a tax item.

Or it can lead to them, making a
terrible choice that can end up

costing them an insane amount of money.

So when you go to a tax
professional, And do you ask them?

Should I consider doing a cost segregation
study on my single family house.

And their immediate response.

Is no.

Absolutely not.

They're not worth it.

Cost segregation studies are
only for commercial properties

or cost segregation studies.

Only ever make sense on a house
that costs this amount or more.

Or no one should do these unless they're
a real estate professional, et cetera.

That should give you a little
bit of reason to guess.

And if you are.

A tax professional who approaches
cost segregation studies.

With such a black and white viewpoint,
then hopefully this episode will

open up your mind to a little
more consideration around them.

a cost segregation study.

It's something that a real estate
investor can have done to a

piece of investment property.

Where instead of just depreciating
an overall building has one asset.

The study has an engineer
go through and allocate out.

Various components of this building.

So instead of having one building
that gets depreciated across 39

years or 27 and a half years.

Now we have other assets
like flooring windows.

Appliances fencing, et cetera.

And because we have values
for all of those items.

We can now depreciate them separately.

And some of those have shorter lives.

Meaning that we can now write
off the cost value of the fence.

Across its correct.

15 year life instead of the
presumed overall purchase

of a property 39 year life.

Right.

Anyone who has bought real estate,
you typically don't receive a

breakout of everything you're buying.

It's normally just the property, right?

You're buying one lump sum.

Of a building of land, have everything
in it, have everything attached

to it, of all of the appliances
that came with it, et cetera.

So people like a cost segregation
study because it's more accurate.

Because it can potentially give us
larger depreciable amounts per year.

And.

Because we've had bonus depreciation.

Which is a fancy word for writing
off a bunch in the first year.

And anything with the life of 20
years or less could qualify for bonus.

So it was preferential to
separate out as much as we could

from that long building value.

Because then it could qualify
for bonus depreciation.

So those are all the reasons, people
like a cost SEG and what they are.

Now let's get into when someone
should actually consider

a cost segregation study.

Like I mentioned at the
start of the episode.

Anyone who provides a clear black
and white when you should or

shouldn't with no wiggle room.

It's probably not the person
to be discussing this with.

There are two kinds of
cost segregation studies.

There are a D I Y a study where you
enter your information on a website.

And it uses a gathered information
algorithm to take a best guessed estimate.

At your values of components.

And spits it out.

We don't like these.

In the past year or two.

I've known multiple colleagues
who have had these DIY studies.

Specifically, fully
disallowed by IRS auditors.

So even though a DIY study can
be under a thousand dollars.

It's almost never going to pass.

An IRS audit.

Now if a DIY study is just
under a thousand dollars.

What can we expect to
pay for a full study?

With a full study.

An actual expert, an engineer
analyzes the property.

They come out and tore it, or they
have you do a video tour of it.

And then they look at the actual size and
components and materials of your property.

And assign reasonable values
based on an expertise.

One of these full scope studies.

We'll typically cost between $3,000
and $15,000 for a single family home.

I know this is quite a range.

On average, if you are
talking about your standard.

Three two and a residential neighborhood.

You're probably in the
three to $5,000 range.

If you have a unique property way
out in the mountains, you're going

to get into that higher range.

Once you go into commercial real
estate, it goes up from there.

So one of the initial things that I
hear when it comes to the question

of who should do, or when should
someone do a cost segregation study?

Is a specific price point of real estate.

A cost segregation is only worth doing.

If the house was $300,000 or a cost
segregation is only worth doing on real

estate of a million dollars or more.

This is a stupid response,
and I'm going to tell you why.

What a property costs.

And what its depreciable value
are, can be dramatically different.

When we have a piece of
depreciable real estate.

We typically have purchased
everything in one amount.

And then we need to
separate out the value.

For the land.

Versus the building.

Land value is not appreciable.

Building value is.

There are some locations
where I have seen.

70%, 80% being all land value.

If this is a tiny house in
a really populated city.

The land is what holds the high value.

Not the tiny crappy house.

That's going to get torn down and
probably built with something new.

If you're looking at houses.

In the rural Midwest.

Then there's a good chance that
the land value is 10% or less

on many of these properties.

So a dollar to dollar comparison.

To say this purchase price
is where it makes sense.

Doesn't matter.

The amount that is
depreciable is what matters.

If you have a $500,000 house.

But 50% of that is land value.

You're only getting to
depreciate $250,000.

If you have a $300,000 house.

But only 15% of that is land value.

You're going to have 255,000
of depreciable value.

So the purchase price of the
house is not what's relevant.

It is what is the depreciable basis?

I will typically say, but if
a property has an appreciable

basis of $250,000 or more.

That's where it makes sense to
look at a cost segregation study.

If it's less than that.

Would it make sense?

Maybe.

Everyone's circumstances are different.

So for me.

$250,000.

Of depreciable value, not purchase price.

That's going to be my sweet spot.

We're from there and up.

I will absolutely look at this.

Most cost segregation firms will also
do a feasibility study on the front end.

now you can do a quick analysis
on what the cost will be.

And the potential savings will be.

Once you have figured out if
the property is worth investing

in one of these studies.

The next question that comes into play.

Is really, is there a benefit
of having the study done?

There are multiple situations.

Where someone is unable to use
losses created by real estate.

Long-term rentals are typically passive.

And passive losses are limited.

Once your income gets above
a hundred thousand dollars.

If your income is above 150,000, you might
not be able to use any amount of losses.

So that being said, A key consideration
of if someone should or should

not do a cost segregation study.

Also comes down to, is there
an actual, usable purpose?

For this study.

Or will you be spending
$5,000 per rental this year?

To get back zero in savings
because you've created.

A hundred thousand dollars of losses.

But you can't actually
deduct a penny of them.

So you need to look at if the
loss can actually be utilized

and help your tax situation.

There are four scenarios where
it is typically worth it.

The first one being real
estate professional status.

If you have real estate
professional status.

Where you spend more time on real
estate than any other activity spend at

least 750 hours a year in real estate.

Then you're normally
passive rental activities.

We'll be classified as non passive,
and as long as you're materially

participating in that activity.

You can use losses.

It creates your only limitation is going
to be the excess business loss limit.

If you're a real estate professional.

And if your property has a
depreciable basis of 250,000 or more.

Absolutely.

Take the next step and look into
doing a cost segregation study.

You'll be able to use those losses
to offset your other income.

See if that helps and make sense
for your tax position this year.

The second time when it makes sense to
investigate a cost segregation study.

Is if your adjusted gross income.

Is under a hundred thousand dollars.

If your income is under a
hundred thousand dollars.

You can utilize up to $25,000
a year of passive losses.

So, what this means is if you do cost
segregation studies this year, And you

create a hundred thousand dollar loss.

You can potentially take a quarter of
that every year for the next four years.

That's not a bad position to be in.

The third circumstance where it's worth
looking at a cost segregation study

would be the short-term rental loophole.

If your rental has an average
guest stay of seven days or less.

And you materially
participate in the property.

It is by nature.

Non-passive it falls out of the
definition of a passive rental.

In this case, any losses that it
generates you can deduct against

your other income sources.

Even if your income is
above that $150,000 mark.

The last circumstance
that people often forget.

Is, if you have a large amount
of passive income for a year.

Including gain from the
sale of a passive rental.

If you have 10 rental properties.

And this year you are going
to be selling two of them.

And you know, you're going
to have a $500,000 gain.

Could you do cost segregation studies.

On one or more of your remaining rentals.

And use the losses that
generates to offset that gain.

Passive rental losses.

Can offset the gain from the sale of
what was a passive rental property.

So even though those losses wouldn't
be deductible against your other

income, had you not sold those rentals?

Because you have sales from rentals in
the same tax year, the gain from the

sale of rental properties can be offset.

By current year or prior year,
carry over passive losses.

If you have this circumstance or, you
know, this is coming up where you're going

to be selling some of your properties.

That is another fantastic opportunity
to look into a cost segregation study.

A few other considerations.

How long have you already
owned that property?

If you have owned that property.

For 30 years already.

And it's a 39 year asset.

You don't have much depreciation left
to separate out and have benefit from.

You've already used up.

Most of it.

The shortest asset class that
we are separating costs into

in a cost segregation study is
going to be five-year assets.

So if you have already owned the
property and been depreciating it

for 10 years at this point, All of
those five-year costs of depreciation.

You've already worn out.

the longer you've owned a piece of
real estate, the less beneficial

this becomes because you have less
depreciation left to tap into.

The next consideration.

If you are doing this
study in a later year.

Your tax professional will
need to complete form 31 15.

With your tax return that year.

Now, this is a pretty in-depth form.

And you can expect to be charged
a higher amount for your taxes.

In the year that it requires a 31 15.

If you look at the
instructions for this form.

It literally notes that
just the time to prepare it.

Not including time for bookkeeping
and preparation ahead of time.

But just the time to complete the form.

The estimated time it has on
the instructions is 21 hours.

So when you are running numbers to decide
if a cost segregation study is worth it.

You will need to consider
both the cost of the study.

And the additional cost
from your tax professional.

To include that 31 15 and the extra
time on your tax return that year.

The final two items for consideration.

On, if you should do a
cost segregation study.

Our two that are often overlooked.

And can be fantastic strategies.

The first one being.

If that rental property was in
service when you purchased it.

And then you have it vacated so that
you can do a large renovation on it.

Doing a cost segregation study at that
point, before you do the renovation.

Effectively means you're going
to get to almost right off.

More than one single renovation.

Let me explain.

If you had no cost segregation.

And the building value that
appreciable value on that property

was a hundred thousand dollars.

And then you went in and spent.

50,000 on a full studs out, rent out.

All of those pieces of assets that
you disposed of everything from

that original property that you
threw out there, floors that were

in there when you bought it right.

The appliances that were in
there when you bought it.

You don't know the values of
each of those without a study.

So even though you disposed of those.

You can't write off any carrying value.

If you have a cost segregation study done.

On the property that's in service
already has a tenant when you buy it.

Then, you know, the cost of.

Those five-year floors.

So if the cost segregation study says
these floors have a value of $5,000.

And six months later, you throw them out.

You get to write off whatever
their remaining carrying value was.

And then you turn around and install
new floors that costs $8,000.

And now you get to treat those new
floors as a five-year asset that

qualifies for bonus depreciation.

So if you buy a rental that is
already in service, when you

purchase it, it came occupied.

And, you know, you're going to
be doing a large renovation.

Doing a cost segregation before
it can have a huge benefit.

The final consideration for if
you should do a cost segregation.

Is, if you are going to
be selling a property.

That you've owned for a while and
it has some 1245 assets broken out.

These are your, what are called
personal assets, personal property.

So this is going to be those items
that we could separate with a cost SEG.

Such as carpet LVP fences.

Appliances are a big one.

You might also have some of these
assets on the depreciation schedule,

even if you didn't do a study already.

If you went through and
replaced any of these assets.

You will probably have appliances
listed as five-year assets.

If you put all new flooring in your
accountant should have separated out, you

know, that carpet as five-year assets.

When you sell.

Those 1245 assets are taxed at
your ordinary income tax rate.

And there's not a cap on it.

Whereas 1250, which is
your permanent assets.

This is what you're building.

That's depreciated on a straight line.

Value is considered.

1250 property.

Is taxed at your ordinary income
tax rate, but capped at 25%.

So a large concern for people
when they sell a real estate.

That has had large amounts
of bonus depreciation taken.

There have been a lot of these
shorter life assets written off

over the years is when they sell,
having to pay those amounts back

for that depreciation recapture.

But at the ordinary income tax rate.

That can be twice as
high as capital gains.

So if you know that that's the case.

Before that property is sold, you should
consider doing a cost segregation study.

Prior to the disposal.

Because again, what this study
does is goes in and Gibbs.

A value of the components
of a property now.

If it has figured out that what this
property had was five-year carpet

and it was installed 15 years ago.

The value of that carpet
today might be nothing.

If it has no value, it won't
have any portion of gain.

So by doing a cost segregation
before you sell a property.

You can potentially shift more
of that gain from that higher

tax 1245 depreciation recapture.

Back into that maximum of 25%, 1250 gain.

So another consideration.

Everyone's circumstances are different.

And your tax situation can
be dramatically different.

Then the person who was told something
was the writer wrong response for them?

So if you have rental real estate,
If you have a depreciable basis on

a property that's 250,000 or more, I
would recommend absolutely investigating

the idea of a cost segregation study
farther with your tax professional.

And if you're a tax professional
listening, who's been a little gun

shy about cost segregation studies.

A lot of professionals still
think they're very, very expensive

and typically not worth it.

That hasn't been the case since T C J a.

Since we had those new, tangible
property regs, there's a lot more

value of the studies and the price
of them has come down significantly.

If you're a tax professional who is
looking for somewhere to get guidance

and to community and mentorship on all
things tax from a point of accuracy

and cited responses and feedback
and support from people who have

been in the industry for decades.

Come check out the insight tax community.

It is an online private
community for tax professionals,

accountants and bookkeepers.

It was established by
four industry educators.

And it is the only community that
requires all technical answers.

To be provided for questions with
some kind of citation or reference.

We're not letting people just
make crap up on Facebook anymore.

If you're in the insight group, you've
got to pick up and put down the receipts

for whatever it is you're saying.

So I hope you come check us out.

As always, I hope that you guys have
found some value from this episode.

Please like subscribe and share.

Thanks so much you guys, and as
always, I will talk to you next week.

Mhm.