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Welcome to Episode Six of Season 10 of the Growing Empire Show. Today I am here with my special guest Joe Viery from the US Tax Advisers Group and we are going to talk about a very interesting subject called Tax Segregation. So stay tuned.

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Welcome to Growing Empires. Hosted by real estate entrepreneur and trusted investment advisor, Jennifer de Jesus. Growing Empires provides insight to building wealth through passive income producing real estate investments for those who want to build and manage a more profitable real estate portfolio.

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Welcome, Joe, to the Growing Empire show. I’m so glad that you’re here.

0:42

Hi, Jen, thank you for inviting me. I appreciate it.

0:45

Absolutely. So let’s kick off this episode with you sharing a little bit about the work that you’re doing now with US Tax Advisers Group.

0:52

Great, thanks, Jen. What we are is we’re an engineering based firm, and we perform a couple of different studies, but what our bread and butter our main study is cost segregation. And what Cost Segregation is it’s kind of a complex part of the tax law. But your listeners don’t need to know the complexities. All they need to know is the basics. And what we do is we accelerate depreciation, which is an expense against income. So bottom line is what we do is we save our clients, income taxes. State and federal.

1:25

Nice. And how long have you been doing this work?

1:28

I started in the industry in 2007. Previous to that I owned, I’ve always been entrepreneurial. And so I owned a business, a different business, it was in the travel industry. And I owned that until 2007. I sold that business and then I started working with the California Association of Realtors CAR. And I was helping the realtors and the realtors clients with income tax and other tax strategies and financial planning. I was I was a securities licensed. And then something happened in 2007 and 8 were the the car that was on top of the cliff went over and when Gary and my little business just evaporated in thin air. However prior to that I had a guy who wanted to talk to me, he wanted to tell me and I thought oh gosh, is probably soap he wants to sell me. Finally a year later I said, Okay, tell me Mike, what do you want, you know, let’s go to lunch. And he told me about this concept which say income taxes. And I had two clients that were staring down writing the IRS checks for 40 and $50,000. I got them situated and they were so appreciative. And then we hit the depression. And the guy that ran the engineering company said, Joe, why don’t you come and work for me, you’re good at this. So I segwayed in, I exited all of my financial planning and all that and I went into becoming a Cost Segregation specialist.

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Very interesting. So today, we’re going to talk about different types of tax planning strategies. We’re going to talk more about cost segregation and why it’s important for real estate investors. I’ve asked Joe to join me to share his wealth of knowledge and secrets that he’s picked up over the years. So today we’re going to talk about exactly what Cost Segregation is and why those studies are so important to real estate investors. We’re going to talk about buildings being sold in the near future and how Cost Segregation could be a factor in that. We’re going to talk about passive investors passive income, we’re going to talk a little bit about the tax strategies and things that you need to know about accelerated depreciation. So let’s actually jump right in. And I’d like you to give me a little bit of a quick synopsis of exactly what Cost Segregation is. Because our listeners, as we’ve talked about, Joe are both brand new investors but also very seasoned investors. Okay, so let’s in layman’s terms, let’s talk about first what exactly Cost Segregation is.

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Okay? So from a very high level, basically, Cost Segregation involves the concept, the IRS concept or accounting concept of depreciation. And basically in layman’s terms, since I’m not an accountant, I will tell you my definition of depreciation is simply the idea that your building is being quote unquote, used up and falling apart every minute, every day, every month, every year that you own it. Because it’s falling apart and it’s being used up the IRS allows you to expense the building as it’s falling apart against your your income. And so bottom line is what most clients and accountants do is they take the easy way out. Because you don’t need an engineer to take the easy way out. And that’s simply you have a make doing example, you have a $1.2 million building in I don’t care what kind it is. And then then you have land. Land is not a depreciable asset. So you somebody’s got to carve out the land portion, the allocation of land, that’s not us because we’re not land appraisers and when we can help you So bottom line in my example, let’s take out 200,000. So now you’ve got a million dollar building basis. And if you’re going to do straight line, your children can do it, maybe one of your pets can do it, all they need to do is grab a calculator and divide for residential, which means single family homes and multifamily divided by 27 and a half years, and you get the straight line amount that you can deduct from your income taxes. It’s an expense. If you have a commercial building, it’s 39 years. So you divide by 39 years, however, I make this really simple all any investor needs to do is look down at the floor. And most of the time on the floor, you’re going to see probably carpet, at least in part of the building. And I will ask my, my clients will that carpet last 27 and a half years, and they say are you crazy, I’ll be lucky the last three years. And so the IRS has a whole, hundreds and hundreds of building components that they put into shorter lives. In the inside of the building, the shorter lives, which is called personal property are five and seven years. And for the outside of the property, their land improvements and their 15 years. So bottom line is if you combine what we find in the 5, 7 and 15, with the main chassis of the building, which is the real property at 27 and a half years, so we’re not getting rid of the 27 and a half years, we’re just carving out the accelerated parts of it. So if you combine both together, that means that instead of waiting 27 and a half years to get your expense, I can give it to you all in tax your 2021. And it is a big number. So in my example of let’s say the multifamily was 1,000,002, we carved out 200,000. So now we have a million dollar building, I’m going to give that owner a minimum of $250,000 tax write off in tax year 2021. Now, they’re still going to get the 27 and a half year, the straight line, they’re still going to get it so it’s not like they’re going like Well, I’m not gonna have any depreciation. So why would I want it all upfront. You’re still going to get 75% of your depreciation. So you’re still going to have a depreciation expense. However, you’re you’re getting all of it front loaded. And it’s it’s the time value of money. Would you rather wait 27 and a half years? Or would you rather get the big bang right now, save the income taxes, take that money and buy more property, fix up a property, take your wife to Europe, maybe buy a car, your children, you know, do whatever you want with the money rather than writing the IRS a check for X for $250,000. Keep that money and let the money work for you. That’s basically it.

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So what is the actual cost segregation study? What is what is that? Like, what are we looking into? Is it everything that you just described? Is there more behind it?

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Lots more. Tons? And that’s why you need to have a firm like mine, because we’re engineering based and the IRS when when they were told by the but basically what happened is IRS got sued by the Hospital Corporation of America in 1997. The judge Judge Wells was so upset with the IRS and their tactics. They said, Okay, guys, here’s the deal. I’m going to grant cost segregation, all of these really ripe, you know, attributes. And I’m really upset with you. So I want you to write out a document that shows how to use cost segregation. So it took the IRS years, but in 2004, they published the audit technique guidelines for cost segregation. Anybody isn’t I’m inviting anybody to go online and type in ATG or audit technique guidelines for cost segregation. And it’ll pull up a 200 page document which tells not only the IRS agents, but it tells the clients what to look for in a quality study. So bottom line is that’s what we do. The quality study is the number one and that is the detailed engineering. So when you have the detailed engineering, what my engineers are doing, is they’re reverse engineering the building. So let’s say you have a building that George Washington slept in, but you bought the building in 2021. Your depreciation clock starts over in 2021. So we don’t care. We don’t care anything except when did you buy the property? How much did you pay for it? And then we got to account to get the land out of that. And so bottom line, what my my engineers do is they look at the building, we send somebody out to the site to measure all of the building components. Both the personal property, the land improvements and the real property. We measure everything the engineers then allocate the correct amounts to those different items. And then we give the accountant our findings and the accountant applies our findings. And so bottom line is Why is it so important to have an engineer? Because your accountants do not know what’s behind the wall? You’re accountants don’t know what’s above the ceiling. Your accountants are not construction expert or construction engineers. So they don’t know this, and I don’t blame them. That’s just not in their wheelhouse. And, and then you have to do the correct the correct allocation of the pricing. So what we do in essence, is, it’s when we look at it to buy for the cost of our 2×4 is not what you pay for it at Home Depot, the cost of the 2×4 is embedded in that million dollar basis. And my engineer has to break out all of this, all of these components compared to the $1 million dollars. So it’s a complex, complex service, and anybody can guess. But obviously, if you guess, and you get audited, you’re on your own. Unless you want to pay me to help you defend your audit. But the bottom line is, if you work with a company like ours, we will defend our work at no extra cost.

10:56

That’s good to know.

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The episode will continue in just a moment.

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As an investor, we know it’s important to stay on top of market trends and real estate opportunities that add value to your portfolio. We also know that having a trusted source of reliable information to help you stay a step ahead of other investors is critical to your success. If you’re interested in having these types of resources, as well as access to me and my team, I invite you to join the Empire Investment Club. A free service that gives you an easier way to make sense of today’s and tomorrow’s real estate opportunities. As a member of the Empire Investment Club, you’ll get access to relevant resources and investment focused experiences such as live interactive webinars, market trend presentations, and investor socials designed to equip you with what you need to succeed. So whether you’re an active investor, passive investor, a combination of both or just starting out the club is where you’ll get what you need to build a portfolio you love. To join, just head over to JenniferdeJesus.com, sign up, and we’ll see you in the club, where everyone’s on a journey to becoming a better investor.

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So tell me why a cost segregation study and services like yours are so important to a real estate investor, specifically a passive real estate investor. But why is it important?

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Well, there’s a couple reasons why it’s important. And I’m going to get a little bit into the weeds, but I’ll tell you that we’re going to blend a couple of different concepts. One concepts is in the tax JOBS Act, in 1997. Part of the provision was a concept called 100% Bonus. And if you don’t know the term, you should google it and figure out what 100% bonus is. But I’ll tell you what it is, it means that the technical reading is it every building component that has a life of 20 years or less, you can expense immediately in tax your 2021 or whenever you do the study. And you can you can take 100% of that. Just so you know, the 100% bonus is going to start phasing out after tax or 2022. So we’ve got one more year the 100. And then it’s going to go down in percentages until it’s it’s gone. Unless, of course Congress, you know, reenact it. Which who knows what Congress can do. They probably there’s a good chance they may reenact it, but if they don’t, you still have two years to get the 100% bonus. And so that’s, that’s big. And so that’s one reason why people should be looking at doing this now rather than later. And then the other reason is because in 2014, there was another big tax bill. It was called the tangible property regulations, the TPRs. And the reason why this is important news, because if you’re dealing in a lot of building types that are value add and multifamily comes to mind because I do a ton of multifamily. And so where I’m going with this is multifamily for a value add in what I’m determining or defining value add is, is simply you’re buying a building, you know you’re going to spend money in rehabbing it. And then you know, you’re going to need to hold the building for a couple of years to make Cost Segregation work, which I’ll get to in a minute. But bottom line is, and then you you spend, let’s say $700,000 or $500,000 on the new improvements. And so why this is important is because a lot of accountants and clients miss this part. So what we would do, what I would advise is number one, let’s do a study on the original acquisition building basis. Let’s use our example $1.2 million. Now I have a million dollars. I look at the million dollars and I break that out and I find $250,000 that can be accelerated. Then you start your improvements. What do you do? You take the carpet, you throw it away, you take the flooring, you throw it away, you take the counters, you throw them away, you take take the countertops, you take the window coverings. All of the items you throw away in the trash have write off value. The only way you can accurately determine the right off value. It’s not again what you go down to Home Depot and buy countertop, that’s not the the value of the countertop in that apartment. The countertop in that apartment, you now have the keys of the kingdom I have in my cost segue report. Now you can determine how much stuff you threw away. Because the IRS does not want to items on on the on the books on the depreciation schedule. So let’s use for example a roof, you put a new roof on when you bought your your million dollar building, part of that million dollars is the roof. So that’s one. Now you rip their old roof off and you put a new roof up. Now you have to the IRS does not want you depreciating two roofs, they want you to write off that roof. Well, how much is the roof you’re writing off? Well, you know it by doing a cost SEG report. And a lot of clients are missing that big, big write off. I tell folks all the time that you know what you’re going to save in just the write off on dispositions, will pay for my cost segregation study in its entirety, probably 10 times over just just for dispositions. Then the final phase will be on the 700,000 you’re putting in improvements or 500,000. Then again, I go ahead and I do another cost seg on that final amount. So the main takeaway here is that if you are doing value add, and you’re throwing any building components in the trash. Now the IRS is not going to take you to tax court to say you didn’t write off that roof. But that is actually the tax law, they want you to write off that roof. And guess what clients need? They need expenses. So yeah, you want to write off the roof, because not only you’re going to accelerate your depreciation, but now you’re going to get a whole bevy of expenses to write off. So it’s a win win win win situation that most I wouldn’t say most, but a lot of accountants just don’t realize the value of the work we do. And so that answers your the first part of your question.

16:51

Yeah, absolutely. So how often do you need to actually do a cost segregation study? Is it every year? Is it every building purchase? Is it? How do you define how often it should be done?

17:03

Yeah, so you hit the nail on the head. So in the original acquisition, let’s say it’s not a value, add, they just bought a building, and they and there’s no money going to be spent, then it’s a one and done. I’m going to accelerate your depreciation, and you’re gonna go on with your life. And then when you buy most of my clients or our investors, so they buy more real estate, you know, maybe it’s one, maybe two, maybe it’s five, some of my clients could be 100. And so bottom line is, is we do the new properties. But here’s one of the caveats to that everybody should understand. There’s a little discussion that needs to be made on depreciation recapture. And so what the IRS is saying is, okay, we’re giving all of these wonderful expenses. But when you sell the property for cash, if you do sell it for cash, then we’re going to tax you on the the depreciation you took. Well, it’s the time value of money, should you get lost in the discussion of depreciation recapture? No, you’re not going to win the arguments that don’t get get, you know, don’t get involved in the argument. But you just need to know that. If you’re going to do accelerated depreciation, you, you must be planning on holding the building for probably a minimum of two years. If you’re going to flip the building with flippers find value in cost segregation, some will. If their IRR is really high, and I save them $1. But you know, they can what they can do with the dollar is triple it, and then they have to pay part of it back? Well, yeah, they’re going to do it. But most of the time, if you’re a flipper, and you don’t have a tremendous amount of internal rate of return, then I’m going to tell them myself, don’t do it. So two years is the minimum that I would want somebody to say that they’re planning on holding the building. Now, here’s the deal. If by chance somebody comes up with a wad of cash, and you sell your building, it’s not the end of the world. It just means instead of giving you like 50 times the amount that you paid me, you’re not going to maybe get that kind of return on the money you paid for the engineering study. But you’re not going to lose money, you just won’t lose. So if you pay me I’ll make up a number of $1,000 to do a study, you’re gonna make your $1,000 back, but I want you to make $10,000. So if you sell it really quickly. You’re not going to make 10,000 You’re only going to get your money back, maybe make a little bit of money on it. And then I have to go into this other segue because it’s really important. But as far as depreciation recapture, one of the misconceptions I get from clients and their accountants is they say, well, well, if I didn’t have to pay my depreciation back again, why would I bother doing it? Well, one of the reasons why you would want accelerate your depreciation is because when you do cost segregation, cost segregation, done the correct way, reduces your depreciation recapture. So I’m going to talk very high level on this. What happens when you buy a laptop? You bought the laptop for $2,000? What’s that laptop worth in five years? Nothing. Well, I would give it $50, but you get the idea. So now because you’ve done cost segregation, you know how much your five year property is, you know, how much your seven year property and your 15 year property. So the argument made to the IRS is, look, I have owned this property for five years, and I just made that up. To make the math simple. I own this property for five years. And let’s say I carved out $100,000 in five year property. So now you’re going to tell the IRS, I’ve used up that that $100,000. So there’s nothing more for me to be taxed on. Because it’s gone. I’ve used it up the 15 year property, you used a third of it up. So you should take a third off the table. Now, do you want to give a little bit of residual value? Like, you know, and I would advise your accounts, you don’t want to be you know, I would advise you to give some like $100,000? I would say 90,000, I would tell the IRS, okay, there was a little bit of residual value in the in the five year property. But this is a pretty important concept that I’ll tell you, most accountants just don’t even think about.

21:09

Yeah, it’s a really good point. So you were talking a little bit about value add specifically value add. And ironically, that’s what we do. Most of our work is in value add properties, right? You know, we help investors acquire the properties, we help them put very strategic improvements in. Sometimes it’s based on cash flow, sometimes it’s based on capital improvements. And a lot of times it’s just cosmetic changes, right? It’s improving the overall condition of the building so that we can capitalize on that market value. You know, whether it be a sale and a couple of years, or whether it’s just the rental income coming in. But that’s what we do we do all value add. So how would you look at the cost segregation a little differently, from a value add perspective, when you do know that somebody is looking to hold the building 2, 3, 5 years or so?

21:56

I’m going to first explain what I just explained, which is, it’s a three tier study. Knowing that, you know, let’s take the first tier. Because that one’s going to be the big low hanging fruit. Let’s take the acquisition building, and then keep in mind that you’re going to be abandoning or disposing of certain assets. So here’s the most important takeaway, either you or your GC or general contractor must keep a list of the quantities that you are disposing of. So it’s very simple, because I will tell you right now, what’s disposed of in multifamily. It’s going to be cabinets, countertops, flooring, window coverings, maybe some type of vanities and maybe something in the bathroom. But that’s not as common as what I just mentioned. So I got to do is just keep keep up a spreadsheet. Okay, on this one bedroom, one bath unit of 750 square feet, we throw away 15 linear feet of laminate countertops. And then it’s easy, then how many did you do? Well, we did 100, well, then I knew you threw it 1.5 million linear feet of countertop, or whatever the math comes out to be in countertops. So if you do that, then it makes it really easy to calculate what the dispositions are. And then when you’re done at the end of the property, that’s not important. All you need to do is determine with your accountant, out of the law, make the number of $500,000 you’re spending on improvements, then, you know, your accountant can expense a lot of those. Because of that TPR the tangible property regulations, a lot of expenses can now be expensed immediately. So take those off the table, and then you’re left over with the ones that are capitalized, that can’t be expensed. And then you call me back to accelerate those. And so so just keep that in mind. You can do it all in one proposal, like one contract. Or you can say, Hey, Joe, let’s just start by doing this phase first, and then come back and help me with the dispositions. Or, in all honesty at no extra cost. I will help the owners and the accountants look at our report to determine the dispositions down the road. It’s really easy math.

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Okay. Thank you for listening to my two part segment with Joe Viery. Please stay tuned next week as we continue our conversation on cost segregation. Until next time, take care.

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For more information about how Jennifer can help you plan, develop and manage a strong real estate investment portfolio, visit growing empires.com.