Do you know everything there is to know about tangible property regulations? Did you know they even existed? You’re not alone because 90-95% of building owners and investors have never heard of them. In this episode, Toby Mathis of Anderson Advisors talks to Kevin Jerry, Executive Vice President of Sales at Cost Segregation Services, Inc. (CSSI). Kevin is a Master of Taxation (MST) and nationally recognized speaker on cost segregation and tangible property.
- What are tangible property regulations? Extremely taxpayer-friendly regulations that represent biggest tax change for industry since 1986
- What’s the benefit of cost segregation for clients? Short depreciation life for many assets for a bigger tax deduction
- What is cost segregation? When you separate property that can be removed from a building, instead of the structure of the building
- How are new tangible property regulations different from those before 2014? For assets currently in service; when a repair/expenditure is made, if you take the expenditure, regulations determine if you spread it over 27.5 or 39 years, or expense it in first year
- What are some things you can write off right now? A lot of expenses by breaking a building into components
- What are the three safe harbors?
- De Minimis: If an invoice has an item on it of less than $2,500, generally, it can be expensed.
- Small Taxpayer: If you take the cost of your building minus land and take the lesser of 2% of that cost for $10,000.
- Routine Maintenance: Based on experience levels, industry standards, and warranties, expense the repair/replacement of a component.
- What if safe harbors don’t apply? There are three other rules: per property, component, or taxpayer; you can’t do both a safe harbor and rule, pick one or the other
- How do you know if your CPA knows what they’re doing? Ask if they:are applying the tangible property regulations to your trade or business
Kevin Jerry’s Phone: (502) 216-5941
Full Episode Transcript
Toby: Hey, guys. You’re listening to the Anderson Business Advisor Podcast. Today, I have an expert in Tangible Property Regs, which if you don’t know what that is, then you really need to listen because this is money in your pocket. His name Kevin Jerry and I just want to say thank you, Kevin Jerry, for joining us.... Read Full Transcript
Kevin: Thanks for having me.
Toby: Kevin, you’ve been doing this for quite a while. He’s an expert, he’s a Master in Taxation. Why don’t you just give a thumbnail sketch for everybody of what you do and more importantly, why you do it.
Kevin: Sure. What our firm does is we restructure depreciation on buildings. It’s called cost segregation where you separate the property that can be removed from a building as opposed to the structure of the building, and the benefit to the client is a short depreciation life for many of the assets, which means a larger tax deduction upfront.
About five years ago, new regulations came out, which are actually the biggest tax change for our industry since 1986. We focus on those regulations because they’re extremely taxpayer-friendly, but what we find is that 90%-95% of building owners and investors have never heard of them. If they have heard of them, they don’t understand them. Again, they are very, very taxpayer-friendly. Like you said, it’s money in the client’s pocket to understand these. I do it because I love it, it’s a lot of fun, and I make a lot of friends helping owners and investors save money.
Toby: The Tangible Property Regs, they came out in 2014, 2015? Right around there?
Toby: Turned the world on its head, especially in real property. You look at cost seg, you look at the accelerated depreciation, and all those things—things that used to be important now became extremely important. Is that a fair statement?
Kevin: That’s very fair especially after the Tax Cuts and Jobs Act of 2017, restructuring depreciation to create more of a front-loaded tax deduction. Really, our business just exploded, but these regulations in 2014 that came out are basically for assets currently in service. When you make a repair or do expenditure on a building, these regulations determine whether you have to take that expenditure, spread it over 27.5 years or 39 years, or if you can just expense it in year one. Obviously, expensing it in year one is much better than having that investment spread over 39 years.
Toby: Right. For someone who’s not familiar with this stuff, you buy a building, you buy it for $1 million, you take the land out, and you get to write off that building depending on whether it’s residential or commercial over either 27 ½ years or 39 years. You’re taking 1/39 of a commercial building and that’s the deduction for the year.
It’s not that great, you’re out-of-pocket. Maybe you financed it but you’re out-of-pocket for that. What these regs do, I think that Kevin is going to be focusing on, are some of these things we can write off right now—a lot of these expenses. The first thing you do is break the building down into components and you say, hey, can I write off any of these components over a shorter period of time? Is that fair?
Kevin: Yes, you got it.
Toby: All right. There are other things and this is really what I want to jump into. A small single-family house owner that’s renting it out knows about this safe harbor of the $2500. No matter what it is that I’m spending, if the invoice is less than $2500, I can write that off this year instead of calling it an improvement or a betterment writing it off over that longer period of 39 years or 27 ½ years.
What I really want to zero in to is are there more things like that?
Kevin: Yes, there are. There are actually three safe harbors. What you just talked about, Toby, was called the de minimis safe harbor. Like you said, as long as the invoice has an item on it of less than $2500, generally, that can be expensed.
There’s also a small taxpayer safe harbor. The IRS has done a great job lately with regulations and making them very small taxpayer-friendly. There’s a safe harbor called a small taxpayer safe harbor. What that is, is you take the cost of your building minus land and you take the lesser of 2% of that cost for $10,000.
Let’s say your building costs $1 million, 2% of that would be over that $10,000. You would take $10,000 or 2% of the cost of the building. Every year, you can do whatever you want to the building. As long as you’re under that 2% or $10,000 whichever is less, you can expense it. That’s very misunderstood. Your CPA or your tax service has to opt-in to this every year. You just have to tell the IRS, based on Code Section 263(a), we are going to use the small taxpayer safe harbor.
You’ve got the de minimis safe harbor. Like you’ve said, $2500 per invoice. Then, you can also elect into the small taxpayer safe harbor so that you have a little bit greater leeway to do more to a building than just $2500. There’s a safe harbor called routine maintenance, which is by far the least understood of all the safe harbors and these regulations. I’ve helped over 1000 CPAs and tax attorneys trying to understand this.
Let’s say you’re doing a repair on your building and let’s say you’re fixing a component that only has a five-year warranty. You know that you’re going to have to do this again within the next 10 years because of warranty, industry practice, just the experience of you running a rental property. You can expense that as routine maintenance. I don’t care if that expenditure is $1 million. If based on your experience, industry standards, and the warranty of the component being replaced, it’s going to have to be replaced again or at least the intent of replacing it again in the next 10 years, you can just expense that. You would be surprised how few people are actually taking advantage of that, Toby.
Toby: What are your better examples of that? I want to go into both the 2% and that once every 10 years. If something has a useful life of less than 10 years, we’re going to bonus depreciate it anyway, aren’t we?
Kevin: Sometimes. The class lives setup for depreciation really has no bearing in real life. Congress set it up as a budgetary situation. By 39 years, by 27 ½ years, how did they actually come up with those numbers? They came up with Congress, decided to look at the budget, calculated how much they needed, and changed the depreciation to longer lives. That’s the beginning. These regulations are set up so that we don’t want to capitalize anything we don’t have to.
You could 179 but then you saw your building at 179, reduce its basis, and you end up paying that back in taxes. If you expense it, it’s not on your depreciation schedule, there’s no recapture, you’re not paying anything back, and you take a one time expense on it. Not only are you now compliant because the IRS says you have to follow these regulations so that you become compliant, but you also have to put money in your pocket and take advantage of regulations that are set up to help you, help you save money, and help your business grow. You don’t want to 179 it or depreciate it if you don’t have it.
Toby: Yeah. 179, for those who don’t immediately trigger their equipment. If you sell that during its useful life, even though you expensed it today—let’s say it’s a car and it’s five-year property. You sell it in year three, that’s ordinary income—the portion of the useful life that was left on that thing. If you sell that just think of it this way, all that money you’re bringing in is ordinary income. Whereas, what Kevin is talking about is if you can expense it, you don’t have a depreciation recapture. You don’t have that same recapture rule. Is that a fair assessment?
Kevin: Yeah. That’s very fair.
Toby: That’s huge for you guys because you’re not looking at depreciation recapture at 25% or whatever your ordinary bracket is up to 25%. What you’re looking at is, hey, I literally get to expense this. If I ever sell the building, I’m just looking at long term capital gains. That’s huge. I want to touch on that. Let’s say that I’m in an area of the country. I own properties all over the place.
Let’s just say a roof. Everybody says that roofs are 20 years. That’s not my experience. Some areas in the country I’m replacing every 10 years. If that’s the case, could I choose to take that as an expense? I know you probably deal with big apartment complexes, big buildings, and things like that but I’m just trying to make it small. Could I write that off as an expense and not have to worry about recapture?
Kevin: Yeah. I don’t want to dance around the issue. I’m sure you hate this next statement.
Toby: It depends.
Kevin: It depends? It depends. I live in Arizona. We have tile roofs that last forever. I come from the northeast where shingle roofs do not last 39 years or 27 ½ years. Let’s say for the de minimis, it’s not going to fall over the de minimis. It’s going to be too expensive. Even the small taxpayer safe harbor’s probably not going to fall under.
The routine maintenance, if the warranty on the roof is 10 years and based on your experience as an owner or investor, you know this roof is only going to last seven or eight years and you’re going to have to replace it, as long as you’re making a reasonable intent—you’re not just making a decision to save taxes, that intent is reasonable, you have industry standards, and experience to back that up, yes, you can expense it.
Let’s say that none of the safe harbors apply. You’re just going down the road and you’re like, you know what? This roof’s going to last me 15 years, so I guess I’ll stop capitalizing it. That is not the case because there are three more steps that you can follow.
The IRS says, is the roof being repaired more than two years after it’s occupied? The IRS says that you can write off an expense item from a building as long as you own the building for more than two years. I don’t know how they came up with two years. Nonetheless, the idea is if the roof degraded before you owned it, typically, there’s really no way you’re going to be able to expense that. If the roof degraded while you owned it and you now repair it, that is a repair. Repairs can be expensed.
Your example, Toby, is really interesting. As long as you don’t make that roof materially better—don’t ask me what material is, it’s very, very, vague; they leave that up to the CPA to determine—and it’s done two years after the date of occupancy, there’s a really good chance you can expense it, especially if you’re only doing shingles.
The last step—I said there were three more—is you can’t affect more than 33% of all of the light components in that building. I don’t want to go off on a tangent and make things really complicated.
I’ll change the example. Let’s say you’re doing an HVAC repair. You’ve got three compressors on top of your roof and you only fixed one, that’s not going to be de minimis. It’s not going to be more expensive than a safe harbor or a small taxpayer. You’re not going to have to replace this for more than 10 years. As long as you don’t make that compressor better, you just repair it then put it in its normal, everyday operating condition where it is now, and you don’t do more than two of that. If you can do one out of three, you’re set. If you repair two of them at the same time, now you’re at 66%, now you’ve got to capitalize it.
There are all kinds of ways to get around capitalization as long as you understand what the structure is, the procedure is, and the questions to ask yourself or your vendor before you even enter and turn it into an agreement, I would say there’s an 80% chance you can expense pretty much every repair that you do on a building, as long as it’s done two years after occupancy.
Toby: All right. Let’s go through that one. That’s very interesting. Can you replace it or it just has to be a repair? Let’s say I have a building here in Vegas. I think we have six big old 10,000-pound big, air conditioners—HVACs. I’ll tell you what, some of these are old. Every year, it seems like we’re having to do something with one of them. I always say, here’s what it would cost to fix it. Here’s what it would cost to swap it out and replace it.
I know I could still expense, but I would have to recapture at some point on some of that depending on if I dispose of the building. Under these regs, are you saying that there’s another alternative where I don’t have to worry about depreciation recapture or I don’t have to worry about 179?
Kevin: Yeah, that’s a great example. Let’s say you don’t want to repair these, it’s not worth repairing. Your vendor says it’s time to replace it. As long as you don’t take the energy efficiency of that HVAC unit that’s being replaced and make it materially better—I’m not an air conditioning guy but let’s say you’ve got 1500 BTUs or 2000 BTUs and you take it to 4000 BTUs. You just made that component better. You made it a lot better. Now, you’ve got to capitalize it or 179.
Let’s say you just told the vendor I don’t want anything better. I just wanted the same exact technology, the same BTU. If it’s middle of the road HVAC, replace it with the middle of the road HVAC. As long as you’re doing one at a time, you can absolutely, positively expense it.
Toby: That’s just an ordinary necessary expense. I don’t have to worry about if I sell the thing within five years. I don’t have to worry about depreciation recapture. I just get to expense it.
Kevin: You don’t have to worry about anything—expense it, it’s defendable. As long as you didn’t make it better, it was two years after occupancy, you’re not replacing more than one at a time, and you’re only replacing less than 33% at one time, you can expense it.
The interesting thing about this is you can replace all of the units in your building over a given time. As long as you’re only replacing them as needed, your vendor may say let’s just replace them all at one time. That’s the mistake because now you’ve got to capitalize that. If you swap them out one at a time as needed, as they start lifting along, you replace one at a time, you could replace them all in a year. But because your effort or your intent is just to replace the ones that are failing as needed, that’s a repair.
Toby: That’s actually pretty cool. Let’s take it and go back to 2%. Let’s say that building is worth $2 million. Actually, I should make this more relevant. Let’s say it’s worth $1 million. I could spend up to $20,000 a year on that building and just call it safe harbor—I don’t know what’s the rest of the term.
Kevin: Small taxpayer. Small taxpayer safe harbor. But you have a $10,000 limit, Toby.
Toby: Yeah, $10,000. All right. I would end up going down to the $10,000?
Toby: Can I use that and use the 10-year repair as well, or do I have to pick one?
Kevin: Yes. What I would say is if you’re anticipating doing a large remodeling, an HVAC, or roof, like you said, I would not apply the small taxpayer safe harbor because you have that $10,000 ceiling that you just can’t go over. I would apply the capitalization or improvement rules that I just explained. The after two-year rule combined with the not materially better, combined with the less than 33% of all like components. I would utilize those regulations instead of the small taxpayers safe harbor.
I always opt-in to the de minimis, I opted for the small taxpayers, but I don’t have to use that. If you’ve got a large expenditure that you’re forecasting and just don’t even use that, you would expense it based on the capitalization rules that are in addition to safe harbors. The safe harbors will put in place as kind of administrative convenience for the IRS. If none of the safe harbors apply, then you have those three other rules that we just talked about that you could do. You can’t do both. If you really want to do both, pick one or the other.
Toby: You pick one or the other. Is it per property, or per component, or is it per taxpayer?
Kevin: Yeah, that’s a great question. It’s basically per trade or business or per property. We’ll just focus on a small taxpayer for right now. Let’s say, you’ve got an apartment complex with 20 different standalone buildings that are not connected. Each building, you can utilize the $10,000 or 2% for each building. If you’ve got 20 buildings and they cost $20 million, each building would be $1 million. You would apply the $10,000 to each building.
You have a lot of different options depending on the facts and circumstances of your entity and the facts and circumstances of the expenditure for that building.
Toby: That is really interesting. I’m just looking at my toolbox. Of all the things I have to pull out, I have my de minimis, I have my 2%, I have my small taxpayer, I have every 10-year, I also have the ability to do my cost seg and use bonus depreciation, and I have 179. I’m looking at all of those tools. They all have benefits and disadvantages, but I have all these different tools. Is that kind of what you do as you’re looking at it, evaluating, and helping put numbers to those tools?
Kevin: Yes. That’s exactly what we do. Based on the intent of the building owner and what he’s going to be spending money on in the future, I help them forecast how to spend money, where to put the money, help them expense as much as possible, and then get the vendor invoices done correctly where we may be able to utilize the de minimis—the $2500. We talk about will this have to be done in 10 years.
If none of the safe harbors apply, you’re still in great shape. I don’t want to repeat myself but I’m going to. As long as you don’t make the component better, it’s two years after occupancy, and it doesn’t affect more than 33% of all the light components, you can still expense it. You almost have six different chances, which is pretty good. You’re in Vegas, I’ll take those odds all day long just to have six chances to win. That’s what we do and what I do in particular, not only going backwards and taking a look at things that may be capitalized that if they were done today, could be expensed. The IRS allows you to go back and expense those, that’s probably another podcast.
Moving forward, proactively, to be able to take those expenditures, that intent, that forecast, and be able to apply one of those six chances to win, that’s where I get my business from.
Toby: Wow. I’m just going to go through those. The six chances to win, I love that.
Kevin: I just made that up.
Toby: You had a look at it. That’s what we’ll call it—six chances to win tangible property regs. How do you know if your CPA knows what they’re doing?
Kevin: Yeah, that’s a really good question. I would flat out ask them, are you applying the tangible property regulations to my trade or business? Most likely, they will be opting into the de minimis and opting into the small taxpayer safe harbor because their software, it’s almost such—I don’t want to oversimplify it, but it’s almost like a checkmark. There’s software where every year you opt into that, but the routine maintenance safe harbor, most CPAs don’t understand that. Certainly, the other three chances to win, they certainly don’t understand that also.
The IRS, to be honest, did not do a good job in 2014 of really helping educate the tax community on how these things work. They put it out there. It actually took them 10 years to perfect these regulations, so they’re going nowhere. The tax community still feels that as long as I capitalize everything, I’ll fly under the radar and I’ll stay out of audit. But that’s not necessarily the case because if you’re capitalizing things that should be expensed, you are no longer compliant with the tax code.
Kevin: Yeah. As a building owner, you’re overpaying your taxes. You want to flat-out ask them—I don’t want to say—are you using the six chances to win because they’ll look at you sideways. But, if you say are you using the safe harbor and the capitalization versus expense criteria to help determine whether my renovations can be depreciated or expensed, that’s just a yes or no. If they say no, call Toby, he’ll call me, and I will—for free. Because I love this podcast, I will give them an hour of continuing education on the tangible property regulations to get them up to speed.
Toby: Yeah. That’s extremely generous. Don’t say an hour because our clients will literally put you on a timer. Just say initial consultation. I’m just going to save you some pain there.
Kevin: Thank you.
Toby: You can go backwards, right? Just because this sounds like hey if you didn’t expense it and you should have expensed it, we should go back in time and go back three years to fix this if there’s a reason. Obviously, if you filed it in good faith, you’re not under an obligation to go back and amend, but you can go back and amend especially if it saves you some money. Is that true?
Kevin: Yeah. What is it is these regulations are a change of method of accounting. In the past, before 2014, most CPAs would have a dollar limit. Look, it’s over $5000, I’m going to capitalize it. Under $5000, I’m just going to expense it. In 2014, the IRS said you can’t do that anymore. You’ve got to follow these regulations. When you change your method of accounting going forward, at some point, the old method of accounting and the new method of accounting are going to meet. They’re going to usually meet in the previous tax year, and they’re going to be inconsistent.
You may have extra expenses or have some capital in. There’s a wide variety of problems that come up when two methods of accounting meet and they’re inconsistent. It’s Code Section 481(a) which says that you apply the new method of accounting to day one as if you’ve always done it and then everything is consistent. In this case, a little bit cost segregation, you actually have a reduction of income of all those closed tax years. If you have done cost segregation already from day one, all of those closed tax years, you just have less income and less tax.
I’m paraphrasing the IRS. They say you know what, don’t open up the closed tax years, don’t amend the returns. Just pull all of the additional savings or additional taxes. In this case, it’s a negative 481(a) which means it’s a reduction in income, which is good. Just pull all of those closed tax years, all of the reduction income, and just put it in the current tax year. We’ll call it even, and we’ll be done with it.
That is called a negative 481(a) adjustment and it takes a change of method of accounting, which is going forward, takes it to day one, and then pulls it forward to the current tax year. There’s a Form 3115 that’s filed. We do all that for you, and you’re off to the race.
Toby: Yup, perfect. If you’re doing a cost seg, you’re doing the change of accounting anyway. If somebody did a cost seg, do you ever look back and say hey, wait a second, not just cost seg. Maybe some of these should be expensed. We’re going to take some of it that we grabbed out of the cost seg and expenses as opposed to accelerating the depreciation. We probably lost half of the audience out there. All it means is depreciation recapture, just remember, is taxable. Expenses are not when you sell the building.
If you’re 1031-ing or you’re going to own it until you die, it’s not going to matter to you, but if you’re going to potentially sell that building at some point or you’re in syndication or something like that, this can be really critical. Based on that, could we actually go back and grab some of the expenses even on a cost seg?
Kevin: Yeah, you almost have to. Before you do a cost seg and you start allocating assets to different class lives, you’ve got to make the determination if any of those assets can be expensed. Before you even enter into a cost seg, before you even think about a cost seg, you’ve got to clean up your depreciation schedule because if there are assets on there that are being depreciated that under the six ways to win rules could be expensed, you can go back, write them off, create a one-time large expense in the current tax year, and then take the rest and keep depreciating it.
It is a method change, I think we’ve just probably lost everybody. That change of method in accounting, it has to be done. You’ve got to get your fixed assets schedule and your depreciation right before you take that next step. Otherwise, the foundation—just like a house, the foundation is very shaky. Let’s get the foundation set, get it cleaned up, expense what we can and what we can’t, and then we’ll depreciate.
Toby: Fantastic. You know what, this is probably one of my favorite podcasts ever. I could geek out with you all day long because this stuff—right now, my brain is spinning in so many different situations. We know the tangible property. I’ve just never heard it put that way. I’m going to spill the six ways to win, and that’s what we’re going to call this one. Just so you know.
How does somebody get a hold of you if they want to get a hold of you? I know that we’re going to put a link off of this. Don’t worry about websites because we’re going to actually give them a link to get in touch with you. If they just wanted to reach out to you, how would they do it?
Kevin: Should I give you my phone number or email?
Toby: Yeah, absolutely. Whatever works. My clients are smart. They tend to be very good investors. They may just pick up the phone and say I was listening to a podcast and I heard you. How would they get a hold of you?
Kevin: Just pick up the phone and call me. If you don’t feel like calling me, you can text me. It’s (502) 216-5941. Again, (502) 216-5941. I live in Arizona, so I’m on Pacific time.
Toby: Don’t call you at 4:00 AM.
Kevin: You can call but I’m not going to answer. Leave a message but 9 times out of 10, I’ll just pick up the phone and talk. I love helping your investors. They are smart. I’m one of your loyal listeners, Toby. I’ll do anything to help people understand the regulations that for once, are in the taxpayer’s best interest.
Toby: Yup, absolutely. You need every little bit that you can to stay ahead of the game.
I really appreciate it, Kevin, for joining us. I will also put all your information up. I just want to say I really appreciate you coming on. I know that time is valuable. I really appreciate your time.
Kevin: No, I appreciate you. You ask great questions and I’ll do anything to help. Thank you so much for having me.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, another great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.