What possibilities are available when you own rental real estate? Different strategies are available to maximize tax benefits. For example, learn how to take advantage of a tax-saving tool that saves you thousands of dollars each year. In this episode, Clint Coons is joined by Brett Hansen of Cost Segregation Authority to discuss such benefits associated with residential real estate investments.
- When you buy property, you can depreciate it over time; Cost Segregation Authority accelerates depreciation to increase your expenses/lower your net taxable income
- If you pay less tax to the IRS, save that money to increase your portfolio and invest in things that get a return; it’s not a deduction, but reduced amount of taxable income
- Smart Tax Planning: Maximize depreciation deduction to reduce tax burden; re-classify assets of a property to identify components that can be depreciated faster
- For assets that you didn’t capitalize on (up to 20 years), you can bring them forward into the next tax return via the Section 481(a) adjustment tax form
- CPA must understand value cost set to use cost segregation for residential property
- Cost segregation studies meet IRS guidelines to protect clients from/during audits
- Changes in Tax Laws: Bonus depreciation – no longer need to purchase new equipment and bonus percentage changed to 100%
- Next Steps: To analyze your property, provide the total cost you paid for it, the year you purchased it, and the property’s address to get the projected benefit and associated cost
Brett Hansen’s Cell (801-884-8358)
Full Episode Transcript:
Clint: Everyone, it’s Clint Coons here with Anderson Business Advisors and, on this podcast, we have some great information for you from a tax standpoint because when you’re investing in real estate, what is one of the major reasons why we want to get started? It’s tax savings. There are those individuals out there that understand how to capitalize on tax savings and those that do not, and most people that I run into when it comes to tax and asset protection planning, there are local guys who just don’t get it.... Read Full Transcript
That’s why many of you have come to Anderson because we’re here to help you out to make sure that your plans are set up the right way so if a lawsuit develops, that your assets are going to be protected. The other side of that coin as you heard me say many times is you want to make sure that you’re reducing your taxes to the greatest extent as possible because real estate is a tremendous tax deduction force. It’s a tax shelter, actually.
You can make a little bit of money or you can make a lot of money from your tax savings if you know who to associate with and know what to look for. So many people do not understand what it takes to look–when it comes to real estate, what they should be looking at to find these deductions. My guest today that I have on the podcast–this individual, I met him at an event that we were both speaking at, and we sat down.
We started talking about the benefits for real estate investors, especially people who have residential real estate and what they can do it. Brett really opened my eyes up to what the possibilities are when you own rental real estate because, possibly like many of you, I always thought that the deduction, the savings that we’re going to be talking about was only available or truly can only be appreciated by people who had commercial real estate.
I have commercial real estate and I’ve taken advantage of what we’re going to be sharing with you but I haven’t done it on the residential side. It wasn’t until we sat down and we had a discussion that the light bulb went off and I realized, “Hey, this is information. This is powerful. This can save people tens and thousands of dollars a year if we can only give them the information to show them how to take advantage of that.”
I thought it’d be great, is that I would bring on Brett Hansen onto the call today and on the podcast and we would talk to you about what this tax-saving tool is and how you can take advantage of it. With that, I’m going to introduce Brett. Brett, how are you doing?
Brett: Clint, thanks for having me. I’m doing great.
Clint: Great, I’m glad you’re on. Why don’t you tell everyone a little bit about yourself and what it is that you do?
Brett: Sure. My name’s Brett Hansen with the firm, Cost Segregation Authority. We’ve worked with Anderson quite a bit, and what we do is a tax strategy called cost segregation. It’s kind of a mouthful. There is no real elevator pitch for it. You’ve got to understand a little bit about what we’re doing. That’s what we’re going to talk about but, essentially, it’s accelerated depreciation on your rental real estate. It applies to anything as small as a residential rental home to my favorite, doing resorts in Hawaii, if you have any of those.
Clint: That’s important. Most people are aware of the fact that when you buy property, you can depreciate it over a period of time. If you buy a house for, say, $100,000, you’re going to be depreciating that over how long?
Brett: 27 and a half years for residential. That’s exactly the point. You touched on that in the introduction where–real estate investing is largely about the depreciation. You’re going to get some appreciation, get the wraps and there’s some other real estate investing, but one of the greatest aspects is the depreciation as a non-cash expense against income. What we do is we accelerate that depreciation so that you don’t pay tax before you have to. It allows you increase your expenses and lower your net taxable income.
Clint: It puts more money into your pocket today by doing that, and the benefit, of course, in knowing real estate–let me put it in real numbers. Let’s say that I made $10,000 in rental income this year after all expenses before depreciation and I had $3000 in depreciation, then how much would I have in capital income in that scenario?
Brett: Right, so you have $7000 taxable income, correct, with the numbers you’re looking at?
Brett: Yeah. If you have more depreciation to add onto it, you’re going to have less taxable income, and then you pay a lot less tax to the IRS, and you save that money and, hopefully, with the proper guidance, you’re using that savings to then increase your portfolio and invest in things that will get a return on that investment.
Clint: See, a lot of those people, when they hear that and they say, “Well, that’s a deduction,” they think that’s money that they’re spending and, really, it’s not; it’s just reducing the taxable income or the amount of income that they’re putting in their pocket that they have to pay tax on. Like we were talking about, let’s say you could get someone $10,000 in depreciation. If they made $10,000 in income and they had $10,000 in depreciation expense, then zero tax, 10K in the pocket.
Clint: Wow. All right, is this a tax loophole or is it something that’s only available to rich people or guys that want to go under the room and figure out some creative strategy and work way over the line or is this a pretty standard strategy?
Brett: I’ll go back and expand what we we’re doing but, to answer your question, it’s not a loophole. It’s simply smart tax planning. The IRS isn’t really good at going and explaining how to take advantage of codes in certain situations but it’s very simple. It’s even on the audit guides about, “You should maximize your depreciation deduction so you can reduce your tax burden.” There’s a quote we could share some time..
Essentially, what we’re doing is we’re going into the rental properties, anywhere from your residential rental to an office building, and we’re re-classifying the assets within that property from its standard, straight-line, long-term depreciation schedule, either 39 years for an office or commercial building or 27 and a half years for residential property. We’re identifying components of those properties that, lawfully and legally, can be depreciated much, much quicker, usually five years and improvements on a 15-year schedule.
You can imagine. If you have, say, a million-dollar property or a hundred thousand-dollar property and we re-classify 25% to 30%. That amount of dollars get puts on a schedule over five years for whatever its asset type may be so deduction is a lot larger. That reduces, effectively, your taxable income, and you have that money saved in your pocket before you have to pay that tax then you use that for increasing your cash flow.
Clint: You’re going in and you’re analyzing the property, then. Is that what has to be done in order to generate this?
Brett: Correct. It’s got to be done both in engineering experience, cost-accounting experience–we have engineers in-house that go and visit every property, take measurements and just, for example, things like having a tree, carpeting, certain flooring, certain wall coverings. All these assets should be depreciated over five years, and that’s a substantial difference over 27 and a half years. We’ll go and engineer, and calculate the square footage of your flooring, the linear footage of your cabinetry.
We’ll count how many trees and bushes you have in the yard of these rental properties and, including auxiliary plumbing, auxiliary electrical, things like that, things that you wouldn’t otherwise think aren’t part of the structure of the asset but should be depreciated–they’re kind of specialty stuff so they should be depreciated by its own schedule, five years or whatever it may be.
Clint: All right, let’s take the cabinetry for example. Say, I have a house that’s valued at $70,000 and it’s a 2200-square foot home. How do you determine how much cabinetry I have in that house? Do you actually have to go in or is there just a table that you work off of?
Brett: No, we go in. We measure. We take pictures. We analyze the property. You all have what you paid for that property–and, actually, that reminds me of a point. Cost segregation is really cool in the fact that I can go back and do a study and re-classify the assets of that component of the house or whatever as of the date you purchased it, meaning let’s say you bought it three or four years ago, this $70,000 home or $100,000-home, and you just have a settlement statement.
You don’t all the way paid for cabinetry. What we do is we apply a cost factor to that cabinetry as of the date of purchase. What the IRS allows us to do is catch up that depreciation from the time you bought it to the time you filed a tax return so until your next tax return without an amended return for cabinetry, or carpeting, or auxiliary plumbing or electrical, for landscape, things like that.
Clint: Okay, so let’s nail that one down because I heard something there that I think is really important. Let’s assume that I bought a house three years ago–and stick with the $70,000-example. I bought this house for 70K. What you’re telling me then, is that you could go in and take a look at that, look at the assets inside of the house, the cabinetry, the rugs and all that stuff, the shrubberies as you stated, and say, “All right, well, for three years, you weren’t capitalizing in this.” You can go in and then bring all those three years forward into this taxable year?
Brett: That’s correct. On the very next tax return, they’ll do what’s called a Section 481-A adjustment, tax–who cares about what code it is, right? It uses a special form that allows you to say, “Hey, IRS, I’m going to change my accounting method. I don’t want to do it straight, long-term way. I want to do an accelerated way.” They say, “Okay, it’s an automatic consent procedure,” and I will dump all those three years of depreciation that you missed on the next return.
$70,000 is probably a light property. We like to look at $100,000 or more, but if you’ve had even $100,000 on a property for three years, that’s where these lower-cost properties are affected with cost segregation because of that catch-up component I just described. You have three or four years of catch-up or 10 years of catch-up. Say that again?
Clint: If you just bought a property today that was $65,000, you’re not going to see as great as deduction as you would if you’ve had it for three or four years.
Brett: That’s a tricky question because the two tax laws, which I’ll get into a minute, will make a difference on this year’s purchases. Let’s say the new tax laws weren’t in place yet and the bonus depreciation, which I’ll take about in a second, wasn’t effective, then, yeah, you wouldn’t see the immediate difference you would over the first five years, and it’s relative to what the fee of the study would cost, which were relatively late. You’ll see a large return on that fee. We want it to be a no-brainer, even as low as 6x to 8x return on the fee, and as the price of that goes up, it’s a lot easier to do that. We’ll talk about that bonus depreciation change in just a second.
Clint: Then how about if I had 10 properties? Would you just do all–can you aggregate them together? Even better. The more, the better.
Brett: Absolutely. The more, the better, and there’s no reason–really, there is no reason you shouldn’t look at each one of them and then get an analysis done at no cost to determine what your benefit is going to be done. With 10, there might be some cheaper, $50,000 or $60,000-ones that don’t really make sense relative to the fee and, no, it’s fine, we’re going to depreciate those pretty quickly anyway. It’s not really expensive, but let’s do the other eight because that’s a big bang for my buck or because that’s giving you enough deductions to reduce your income to zero.
Clint: When you make that election that you were talking about, that’s on a per-property basis so I don’t have to treat all my properties with that election. I can choose which ones I want to use it for which ones I don’t.
Brett: It is on a per-property or, at least, on a per-entity basis.
Clint: Okay, per-entity. That makes sense.
Brett: If you go back into that LLC and then – and most people have different LLCs per home. It depends on how you’ve structured that. You can probably be best advised for that, but, yeah, it’s per-entity basis.
Clint: All right. Planning-wise here, if I was an investor and I made the mistake because I went and put it and I put eight homes in one LLC, it’s not the best asset protection. If we’re going to run this study, it might be good to pull out those newer properties that I purchased, the $55,000, $60,000-homes, drop them in a separate LLC, create a new one for them, and then do the analysis just on that one LLC because we have to make the election change for that company.
Brett: Yeah, you could do that, or maybe we just make it so that we do all the properties within the LLC. You just do them all. Even if you do the change LLC, you don’t have to do a cost segregation on all the homes within that. The depreciation will just change per asset, and that depreciation deduction will flow through the LLC’s tax return and then it may or may not pass through the entity owner itself. You don’t really have to shift them around in different LLCs; you can just pick what changes you want to do, what studies you want to do.
Clint: Okay. What we’re talking about here is creating this depreciation deduction that you can take under your tax return. You’re talking about, if you have a three, four of five-year old property there, you can go back and pull all that forward. Is there a time when that no longer makes sense? The cut-off should be, if I’ve owned it for 10 years, it doesn’t make sense, or 15 years?
Brett: Yeah, and I’ve done successful studies this year back to 1997. It’s a hard number to remember but, yeah, it goes back to at least 20 years. After that, it’s usually fully depreciated already. We’re just accelerating that depreciation. After 20 or 22 years, there’s not a lot of benefit left because you’ve already fully depreciated that asset, but I want to see everything over $70,000 since 1997. If you have a depreciation schedule or a list of properties of assets you’ve owned that are rental properties that you’ve had since that day, then let’s take a look at it and see if we can reduce your taxes.
Clint: In years past, you’ve been–how long have you been doing this?
Brett: Myself? Four years. The company’s been around for 12 years. Cost segregation has been largely started in the early 2000s, 2003, 2002. Like you said in the beginning, it started out with casinos and hospitals only; multimillion-dollar properties could afford the fees. We’ve cut that down to–you’re talking residential rental homes at $100,000 can really benefit from these savings. That impact is huge for a small investor that has maybe six homes, saving 10-20 grand in taxes in a year.
Clint: That’s not small change. What happens to the investor who’ll go to their local CPA and they’ll tell them, “Hey, I heard about this strategy where we can accelerate the depreciation and put $20,000 back in my pocket this year,” and the CPA says, “You can’t do that because it’s residential real estate,”? I’m sure that’s come up before. How do you address that?
Brett: You’re talking about a situation where the CPA doesn’t quite understand the value of cost seg or they just think it’s only for super-million-dollar properties. We would love to work with that CPA. We would have to educate them on the value of that. There’s no secrets to what we’re doing. It’s all transparent. Often times, the CPA will note there’s an ego thing there or whatever. They don’t want to lose the client or they’re protecting their butt over their buys. I get that. They need a second opinion.
Clint: Yeah. I found that, a lot of times, if they’re not up on it, they’re going to be down on it, and that becomes an issue.
Brett: It does make them look bad.
Clint: Yeah, exactly, like, “Oh, you mean I could have been saving this for the last four years?”
Brett: That’s true. Most CPAs, the good ones, are like, “Oh, thank you for showing this. We’ve learned about it and we’ve heard about it, but we didn’t know how to do it,” and that touches on a point like, “Yeah, all the big four firms have their own costing division.” We work with all CPA firms across the country. We want to be their service provider for this. This is all we do, is cost segregation, and there’s no reason for a firm to open up a branch of cost seg just for their clients with all the expenses associated with that. We will do it for you. We work hand-in-hand with a CPA such as your firm yourself and make sure that they’re getting the service they need.
Clint: Yeah, have you ever had one of your returns audited?
Brett: We have.
Clint: Yeah? How’d that work out?
Brett: By “returns”, you say the studies, right?
Clint: Yeah, the studies.
Brett: Back to the loophole question, we’ve done thousands and thousands of studies across the country, and we’ve been involved, I think, to date, in nine audits over the last 10 years. None of those were because of the cost segregation studies itself; it was for another issue with the tax return. The agent will say, “Oh, there’s accelerated depreciation return. We’d like to see how you did it. Who did you use? What did you do? Did you just throw a dart and guess what percentage of cost of this carpet?” If you do that, you’re in trouble.
If you have a qualified study that meets the IRS guidelines that our company provides, then we never have any changes and then you’re pretty safe. We will support that. If anything gets audited, there’s no cost to help us support our reports, and it’s very little risk as long as you’re doing these studies correctly with the guidelines.
Clint: See, that’s so important because I’ve run into people before. They say, “Oh, my CPA’s doing a cost seg for me,” and I’ll ask them. I’ll go, “How are they doing?” and they told this: that they have software that figures it out. I’m just shocked. That’s just setting yourself up for an audit, and I know from personal experience that those go, “Oh, yeah, you’re right. You saved a few hundred bucks,” until you’re told you have to pay interests and penalties on what you did because you didn’t do it right.
We had this LLC. This person passed away. Actually, it was a limited partnership, and she passed away. It’s worth several million dollars and we wanted to get a discount valuation on the LP. I hired someone to do an analysis of the limited partnership to determine what the value of these units would be because it would save them about $375,000 in state taxes. Now, when I presented this to the individual, they said, “Well, how much is it?” and I said, “It’s $35,000,” and they just flipped out and lost it.
I said, “Yeah, but look at how much money I’m going to save you.” Now, thankfully, they followed my advice and we hired this individual to come in, analyze the limited partnership and come up with their discount valuation. They had a study that they used to support it. That study was approximately 60 pages in length. That return got audited. To your point and what I want the listeners to understand as well is that, when it was audited, all I had to do was send over that study that was done on the LP to support the discount valuations, and they dismissed it.
That’s why you don’t–software does not do that. People have to realize you paying for services is going to provide for you a tremendous tax benefit going forward, and so that’s why you’ve got to use someone that understands what it is we’re doing here.
Brett: That’s correct. We’ve got stories like that, too, and, usually, they’re dismissed with just handing over a properly-done study. We’ve got one. We went to an agent and he wanted to use a different case law or different case precedent for some of our deductions and so we said, “Okay,” and then increased the deduction by half a million dollars.
Clint: Isn’t that great?
Brett: He walked right out and he’s like, “No, we’re good.” If you’re doing it right and we will back it up, full support–we’ve been around forever–we’ll be there.
Clint: Now, we all know there’s been some changes this year in the tax law. Tell everyone about what they can do, especially this year, and why it’s so important to actually take advantage of this.
Brett: We teased about it a couple of minutes ago, and there were several changes to the tax code that have impacted cost segregation. There’s one in particular that I need to address as ground-level as I possibly can, and that’s something called bonus depreciation. Bonus depreciation has been around since 2001, actually. It’s a stimulus idea. It was designed to help people invest in equipment, and what it did is it allowed you to take a certain percentage of depreciation in the first year, but it had to be new construction or it had to be a new asset and then it had to have an asset life under 20 years.
Also, we’re doing their cost segregation studies, and we’re re-classifying a bunch of assets from 27 or 39 down to 5, 7, or 15 lines so also they qualify for bonus. That’s bonus depreciation. In the past and up until a long time ago, 2017, that was 50%. There’s two significant changes that happened with the new tax law. Number one, it no longer has to be new. This is huge because, now, anything anybody is purchasing now qualifies for what’s called that bonus depreciation. Now, if they get a cost seg study done, we’re identifying an average of 25% to 30% of that cost as an asset life under 20 years. I don’t know, Clint, do you know what that new bonus percentage is?
Brett: It’s 100%, meaning everything we identify through a study is now expensed in Year 1. If you take–we’ll use $100,000, which I’m told many don’t exist anymore, and we re-classify 30% of that so $30,000, you’ve bought something for $100,000 and your deduction from that asset is $30,000. Multiply that by your tax bracket or your tax rate, and that’s your true saving from the asset that you just bought. Another is a good land, of course, but, yeah.
Clint: If you’re in a 30% tax bracket, then that’s close to $10,000, is what you keep.
Brett: That’s $10,000 off the price, just right off the top, just by buying it. I am encouraging. I am giving out as much as I can to CPAs doing this tax-planning phase for the next two or three months. Get something closed up by the end of the year, and if you foresee a big tax bill coming up for 2018, go buy yourself a rental home. Relative to your bill, you use the deduction with your tax advisor and work together with that. If you need some deductions, go buy some real estate.
Clint: Let’s assume that I have more deductions than I do income. What do I do with that?
Brett: It call carries forward. It creates a passive loss, they will carry forward indefinitely, and you use it up as far as long–but that’s another tax code change. It used to be 20 years. Now, you can use it for as long as you need it.
Clint: Now, this 100% bonus depreciation, though. I think we should be a little more clear on that. That’s only available for 2018, correct?
Brett: Incorrect. It goes through the end of 2022, assuming nothing changes by then, which who knows.
Brett: A lot of my CPAs are like, “Let’s just get all the deductions we can. We never know if it’s going to change.” For example, that was supposed to be phased out at the end of the next year. Bonus depreciation was going away in 2019 until the tax law came in and, now, bonus depreciation has changed to affect existing properties and new properties alike. It’s 100% bonus, 100% expense, and it goes through the end of 2022. After which for the next four years, it pays out 20%, so 80%, 60%, 40%, 20% as opposed to some said at the end of 2027. I can’t even think that far ahead. Tax laws and things have changed in the political atmosphere.
Brett: We’re just like, “Get the deductions.” If you can’t use it all, your bill’s loss has built up, if you have the losses built up, then certain capital gains will trigger use of those losses to sell the properties. There’s a lot of more strategies. I’m sure you can advise with your clients that help you maximize these tax methods.
Clint: Absolutely. Then, we’re looking at doing this–let’s say I want to take advantage of 2018. Do I have to have all the studies done for 2018 or can I start the process and, as long as it’s done before, do a tax return? Does that work?
Brett: That’s correct. We need about 30 days unless it’s peak season, end of tax year, like last September or October. We need 30-40 days to complete a study but, as long as you purchase the asset by the end of the year, I have until maybe March to finish the study and, as a CPA, would like it early April for sure and have them a few days to input that deduction to their tax return.
Clint: If I was doing my return on October because I found an extension, then I could actually go all the way until October 15th?
Brett: Yeah. Just give us some time to get it to the CPA a little bit before the 15th. They don’t want throw a schedule right on them and pay taxes due, not that I didn’t do that for 12 times a few Mondays ago. It will go by the date you purchase the asset and then we have up until the next tax deadline to give you that information.
Clint: That’s going to be a huge tax savings for people on top of the tax cuts that came in this year. If you’ve got rental real estate, take advantage of this bonus depreciation with the cost seg. I know a lot of our clients may be able to put themselves in a zero-income situation, and that’s important.
Brett: The tax savings, you’ve got to use these for then further your portfolio, build your wealth from it. Invest it in the market or maybe don’t go buy a boat or go buy a boat. I don’t care, good memories, right?
Clint: A fast car, yeah. Anything else about this topic that they need to know?
Brett: I think the best way is the next steps in terms of, “What do I need to analyze a property and make sure it fits for you?” I only need, really, two and a half things, or maybe three things. I just need the total cost you paid for, that year you purchased it and, if you have an address, that’d be fantastic to shoot over my email. I like to look at the asset, kind of see what’s involved, how big it is, things like that.
We will come back to you usually within a day on the projected benefit and its associated cost, and the costs are low. From a single-family rental, I’ll tell you you’re talking less than $2000 depending on the size, its location. The average for a commercial building is right around 10, maybe 8 or 9. They’re way worth it and then it goes up from there, but we like to see a large return on investment for that fee.
Clint: Now, that’s great. If somebody wanted to move forward to get a cost seg done on their rental estate, how would they go about contacting you?
Brett: We have a website, Costseg Authority. We have an 800 number, 800-403 115, and you can call me directly on my cell 801-884-8358, if that helps. Just call us or email us. We pride ourselves on service. We work well with Anderson and just really enjoy working with people and saving them tax dollars.
Clint: Great. I hope a lot of people that are listening to this or watching it on my YouTube channel definitely take advantage of this and reach out to because, if we can put an extra dollar on our pocket, that’s just another dollar that we can take and use to pay your attorney. No, I’m just joking. Go out and invest with and buy more real estate. You wonder why how many people are able to accumulate so much in property, and a lot of it comes down to how they do it, having the education. Those individuals, they have access to that knowledge, and what we’re doing now is we’re giving people access to the same things the very wealthy people are doing to lower their taxes.
Brett: You touched on it. As you close up, you wonder why all these political figures don’t have seemingly large tax bills. They’re large but not relative to their estate because they’re using concepts like cost segregation.
Clint: They get criticized for it.
Brett: We just know, and it is. Ignorance can hurt you sometimes. Learning about this, employing these strategies will help with wealth, and grow your portfolio, and make some more money.
Clint: Hey, thanks for taking the time with me today to go over this information. I know we’re getting a lot of people that are going to be reaching out to you and, with that, thanks for coming on.
Brett: Thanks for having me. I appreciate it.
Clint: Alright, bud. Take care.
Brett: Yeah, take care.