Cost Segregation Real Estate (BIG Advantages of Accelerated Depreciation!)
Articles Blog

Cost Segregation Real Estate (BIG Advantages of Accelerated Depreciation!)

(light music) – [Toby Mathis] For an
investor planning on buying and holding real estate, would you recommend cost segregation? So this is interesting,
so when you say investors, so then we’re buying
and holding real estate. So this is long-term,
so this isn’t a flipper. Cost segregation just means this, and I’m gonna write this up so you guys can kind of follow along. So if you have rental,
and we’ll just call it residential single family residence. You write off the value of the house, the improvement on that
property over 27.5 years. So let’s say that you buy a house for $350,000 and the land value is $75,000. That means the improvement,
the house itself is worth $275,000. You would divide that by 27.5 which is gonna give you
$10,000 a year of depreciation. So that’s standard depreciation. This is the modified
accelerated cost recovery. So what ever that is, MACRS. And correct me if I get
anything wrong Jeff. You’re the accountant. – [Jeff] I’m watching you. – [Toby] Let’s say that
we have rents coming in at $10,000 a year, we just
wouldn’t pay any tax on it. And we’re talking net rental. But what if we have net rent coming off of this of $30,000 a year? So we have $30,000 a
year coming in positive, minus the 10, that gives me
total taxable income of $20,000. When does it make sense to
try to jump this number, this $10,000 up? What if I could make that higher? And that’s when you do
the cost segregation. Because let’s say I’m in
the highest tax bracket in a state like New York,
Connecticut, California, something with a high state
tax, Baltimore, you name it. Or Maryland, because
Baltimore’s not a state. Maryland.
(Jeff laughs) I know, people are making fun of me. I’m making fun of myself. $20,000, that’s gonna get hit pretty hard. In some cases 50% so I don’t
want that $20,000 to hit me. Then I may look at this and say, hey, instead of looking at it in taking the traditional MACRS sense, I’m gonna break this down into items that are less than 20 year property and the structure of it. So for example, if I walk into a house and there’s a chandelier in it, that chandelier isn’t
part of the structure. I could break it off and write it off over a shorter period of time. Or there’s heater covers. Or everything from HVAC to
your boiler, to you name it. To your whatever’s in that house. Appliances, everything else,
you break these things out. They’re not part of the structure. And if I break those out,
I can write those off. Right now with bonus depreciation,
all in the first year. And the rule of thumb, I’m just gonna say rule of thumb is 20%. Is about what you’re gonna
get in that first year. So rule of thumb is I
would get an additional, just multiply that by 20%. So what is that, $55,000. I would get an additional $55,000. So I wouldn’t pay any tax on that. Let’s say I’m making $20,000 a year, It would be a good 2 1/2 years before I’d be looking at a taxable event. And by that time, maybe
I bought more property and I keep bonus depreciating. Now that’s the classic sense of when you do a cost seg is when you have either too much money coming in or there’s a flip side. If you have one spouse who
is a high net income earner, so they’re making a lot of money. One spouse is making a
lot of money, spouse one, and spouse two can qualify as
a real estate professional. And then you can create losses through the use of cost segregation, to subtract from this so you get a loss so you can lower their income. That’s the typical times when
you’re doing cost segregation. I hope that was in English
so you guys could follow it. So whenever you’re buying
and holding real estate, it just becomes what’s your tax appetite. If you’re already creating loses and you’re just carrying them forward ’cause you’re not a real
estate professional. And a real estate professional is when you hit 750 hours, that’s your number one use of time, and you materially participate in your real estate activities. If you hit those tests, then you could be able to take real estate loses and offset active income
with your real estate loss. And Louise, you can do cost seg for both commercial and residential. It used to be it was just commercial, now you can do it against
a single family house. It was never cost beneficial before but now you can get ’em done, I’ve seen ’em done for 1500 bucks. So you get a big, old, fat write-off if you’re doing the cost seg. And it’s whether or not you
can get the benefit out of it. So you know. What about renting a condo
which has window upgrades? Is this cost segregation? Probably not. It depends on what the
value of the condo is but yeah, you’d break it all down and say, hey, I just had a whole
bunch of windows done. You know, maybe those aren’t gonna be 27 1/2 year popery,
that’s gonna be much less, and I’ll probably get to write them off in the year that I did it. It all depends, all depends. So it’s a little calculation that you do. But I can tell you that the bigger your tax appetite, the better. And then it says, if you become a real estate professional at tax year, after you did the cost
seg and carry over loses can you write it off or is
it trapped passive loss? It’s trapped if you’re an investor before, real estate professional
is only for the year. Jeff, am I missing any of that or is that your understanding too? – [Jeff] No, that’s correct. And the other side of that problem is when you become a
real estate professional, you have to aggregate all of
your real estate activities together in the one activity. – [Toby] This is one of the
most misunderstood areas, and unfortunately it’s ’cause we had a bad court case that came out and they didn’t understand
real estate professional and whoever was convincing them, they were all wrong and
so the court was wrong. But there’s two tests, there’s the 750 hours, number
one use of your work time (bells dinging)
which one spouse has to qualify for and then, Jeff, we’re gonna put the cat cone on you. (Jeff laughs)
And then there’s the, if anybody’s ever been to my event, you know what the cat cone is, right? It’s anybody’s who’s playing
with their phone during it, we’re gonna slap the
cone of shame on them. So they can’t play with their phone. – [Jeff] I don’t know whose
phone that was. (laughs) – [Toby] Blame it on one of the techs. – [Jeff] It was the dog,
it was the dog’s phone. – [Toby] Anyway, I don’t
even remember where I was. I was blabbling about something,
probably some nonsense. It wasn’t my fault, it was everybody else. All right, so I even don’t
remember what we were going on. – [Jeff] So wouldn’t
it even make more sense if it’s commercial property? ‘Cause there you’re
looking at 39 year lives instead of 27 1/2 year life. – [Toby] Yeah, absolutely. And you’re gonna get much juicier amounts when you have a commercial property worth $1 million and you’re gonna get an extra $200,000 write-off right now. And if you’re never planning
on really selling it. You’re gonna hold it. Maybe you’re gonna trade
it for more real estate. You’ll never pay tax on that cost seg. All you have to do is eventually pass away and your basis steps up. So it’s one of those things where if you just sit there and let it happen. Oh yeah, tests for the
real estate professionals is two requirements. See I get lost, sorry guys. Blonde. All right, so you have the
real estate professional, which either spouse can pass, and then you have the
material participation in your real estate activities. Which is a material participation is combined spouses spend 500 hours, or 100 hours and it’s the most time spent on your properties
than anybody else, or you did all of the
time on your real estate, in which case we don’t
care about how many hours. So that’s material participation
but that is per property. So when you do the material participation it is per property unless
you choose to aggregate it. If you aggregate all of
your rental properties, then you just apply it to one. So, let’s say I have 10
pieces of real estate and I spent 50 hours on each one and it doesn’t matter
whether it’s me or a spouse ’cause we add it all up together. But I would not pass the
real estate professional test even if I did the 750 hours, because you have 750 hours per
year, but it’s each property. I would have to be either
I’m doing all the management or I am doing 100 hours
total and nobody else is spending more on each property. Unless I choose to treat them all as one activity and then I don’t. But I actually have to make
an affirmative election. And accountants miss this, guys. You wouldn’t believe it. There’s court cases where people spent more than 750 hours
and they could show it but then the IRS looked at
it and appropriately said, but you didn’t aggregate your properties. You had a bunch of properties but each one you’d have
to meet the hourly test. And they had management companies. So you’re basically having to meet the 100 hour test on
each property at least. Or you do 500 hours total,
then you don’t have to care. So this is something
says, are you considered a real estate professional if you have a property management company? You still could, it’s 750 hours and you materially participate. That’s it. You don’t have to. And it’s 750 hours but it’s the
number one use of your time. So it can push the 750 hours up if you spend 1,000 hours in
your day job, for example, but you spend 1,001 hours in real estate, then you would meet the real
estate professional standard. But if you did 1,000
hours in something else and 750 hours in your
real estate activity, you would not meet it ’cause it’s not your
number one use of time. What if my day job is a real estate agent? Then as long as you’re involved
in real estate transactions, during the buying and
selling of real estate, then it qualifies. So you would meet the 750 hour test. So we have somebody who says, what if my day job is a real estate agent? This is a great example. Let’s say that I have
three rental properties and I want to qualify as a
real estate professional. You would say, hey, they
meet the 750 hour test. They may be doing 2,000 hours but then they have to
materially participate in their rental activities too. Somebody says, ’cause that is what I did in the past with the IRS. Absolutely. So you qualified under both tests. So you’d still have to spend
time on your rental properties. So yeah, you guys are now jumping all in. So I love that. So people are out there– (upbeat piano music)

One thought on “Cost Segregation Real Estate (BIG Advantages of Accelerated Depreciation!)

Leave a Reply

Your email address will not be published. Required fields are marked *

Back To Top