There’s no such thing as a perfect investment … but real estate sure comes close!
But with any investment … you have to be smart. One important aspect of smart real estate is taking advantage of powerful tax breaks.
We’re diving deep into one of the best tax benefits that real estate offers to investors like YOU … cost segregation.
In this episode of The Real Estate Guys™ show, hear from:
- Your appreciated host, Robert Helms
- His depreciating co-host, Russell Gray
- Cost segregation authority, Erik Oliver
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Increase cash flow and reduce taxes
You can make a lot of money in real estate … but you can also pay a lot of taxes.
Today, we’re going to show you how you can increase cash flow and reduce taxes with investment real estate.
Beyond monthly cash flow from a real estate property, you can also make money as your property appreciates over time.
That equity is locked into the property until you do something about it … like refinancing or selling.
You also have the benefit of amortizing a loan. Every month when you make your mortgage payment, part of it goes to pay interest while the other part pays down the principal. Each time you pay down the principal, you own more of the property.
But the way to make money we are focusing on today is … tax benefits!
CPA Tom Wheelwright has taught us that if you want to know what a nation wants its citizens to do with their invested capital … just look at the tax code.
The tax code is a series of incentives … and these incentives will benefit your bottom line and enhance your cash flow.
The tax code can be especially helpful in those early years of purchasing a property when there is a lot of expense … above and beyond what you get over the life of the property.
We should remind you that we’re not tax advisors or professionals. We give ideas and information. We’ll be sharing a lot today … but sit down with your tax professional before you make any major decisions.
Make sure you have a tax professional that truly understands this niche … preferably one who owns investment property themselves or whose practice serves a large percentage of real estate investors.
And … don’t let the tax tail wag the investment dog.
You don’t want to invest in something just because of a tax benefit. Instead, find a great market, a great property, a great niche.
Then, you’re going to seek to exploit the tax law legally in your favor to the best degree you can.
Today, we’re going to talk about a tax benefit that most multifamily and seasoned long-term developers and investors know about … but many smaller investors haven’t discovered yet.
What is cost segregation?
Erik Oliver is an authority on cost segregation.
Depreciation accounts for a loss of worth in your asset. Some things depreciate, while others don’t.
Land doesn’t wear out … so it isn’t depreciable. But gutters do … so they are.
“Cost segregation is simply accelerated depreciation,” Erik says. Many people get into real estate in order to take advantage of the depreciation loss.
“We depreciate our real estate over either 27.5 years for residential properties or 39 years for commercial properties,” Erik says.
Cost segregation means that you accelerate that timeline instead of taking 1/39 of your depreciation each year.
It starts by identifying the different components of your building and segregating out those components into shorter asset lives.
For example, the IRS allows you to depreciate carpet over five years. Instead of having to lump that together with your 39-year asset cost, cost segregation comes in and puts a value to that carpet, allowing you to depreciate it over a much shorter time frame.
Accelerating the depreciation means more tax benefits, sooner.
Let’s put some numbers to it for a simple example.
If you own a $270K duplex, you’ll get to write off $10K every year against your income for the next 27.5 years without doing cost segregation.
If you were to do cost segregation on that duplex, the analysts will identify roughly around 30 percent of that $270K and categorize it into 5, 7, or 15 year property.
Depending on when you bought the property and what the laws were at that time, you may be able to write off all of that 5, 7, and 15 year property in year one.
That’s over $70K that can be written off in the first year instead of $10K.
What does an analysis look like?
Cost segregation is a process generally done in conjunction with an engineering firm and accounting firms.
In order to complete a cost segregation study, you’ve got to have construction engineers that can go in and reverse engineer these buildings, so to speak.
You also have to have someone with tax knowledge to take that information and make it work for you.
Many CPA firms will partner with an engineering firm to offer this service to their clients.
The IRS has actually put out an audit guide that most cost segregation companies follow. It’s 13 steps and requires a site visit.
“Typically, we’ll send one of our construction engineers out to the property for them to do an inspection,” Erik says. “They’re looking for things like retaining walls outside, drainage in the parking lot, what type of flooring and window coverings are used, etc.”
The resulting reports are pretty detailed … usually about 40 to 60 pages long. They basically line item every component of the building.
“We do go over everything from flooring to cabinets to countertops. We’ll even go out and count the trees and bushes,” Erik says.
Cost segregation studies can cost anywhere from $7K to $15K. Erik says he recommends you get an estimated cost for a study for any property over $200K.
“Sometimes, depending on a number of variables, it may not make sense to do a cost segregation, but you should always look into it in case it does make sense,” Erik says.
Most cost segregation companies will do a free benefit analysis to make sure that you are going to get significant tax savings from completing the study.
For more on cost segregation … listen to the full episode!
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