What type of expense do you prefer to deduct? There are deductions that you recapture, there are deductions that you don’t. There’s bonus depreciation, and there are flat out expenses. They’re all different.
In this episode, Toby Mathis of Anderson Advisors talks to Warren Dazio, Executive Vice President – Business Development for Cost Segregation Services, Inc. (CSSI). The engineering-based consulting firm focuses on the tax law for commercial buildings.
As a natural leader, Warren brings ethics and integrity into every aspect of his life and work. He spent the first 20 years of his career in ministry and has a degree in theology. Later, he pursued an advanced degree in business and received an MBA.
Highlights/Topics:
- What is cost segregation? Accelerated depreciation on building to reduce income taxes.
- Why is self-storage so popular with investors? Self-storage is a strong investment option because of TPR, cost segregation, and sometimes, 179D.
- Can tenants be a pain to deal with? People still deal with tenants, but automation means doing less with those tenants.
- What’s more beneficial from a tax standpoint, build or convert self-storage buildings? Converting existing buildings into self-storage gets massive deductions from cost segregation. Building a self-storage facility from ground up has tax benefits, as well.
- Besides the cost segregation, are there tax credits that are like cash? Yes and no. A deduction that self-storage can qualify for is 179D. Research and development is a credit for credit, and a 45L associated with residential rentals is a credit.
- Is there a dollar amount with 179D that you get per square foot? Yes, it’s anywhere from 30¢ to $1.80 per square foot. Focus on the building envelope, HVAC, and LED lighting.
- Is that subject to recapture? Gains are under other deductions on your tax return. If it’s a deduction, it may be subject to recapture. Tangible property regulations don’t have to be recaptured, but bonus depreciation does.
- If you’re building a self-storage facility or making a modification, if you do it right, you can get major tax relief, correct? Yes, you probably already covered the associated TPRs, and might have covered partial asset disposition (PAD).
- Is there a PAD available? Have you talked to your CPA about it? If your CPA is not aware of it, call a firm that helps you put a dollar amount to the write-off to gain from it. CPAs may not be qualified to do this work.
- Can you capture qualified improvement property? Can you capture a bonus? You can capture Section 179, which is a bit different from 179D. Section 179 and bonus are similar. 179D is the energy piece.
- What are the different types of cost segregations? The gold standard is the engineering-based method that captures accounting and construction dollars.
Resources
Cost Segregation Offer: https://bit.ly/CSSIGREGBALL
Warren Dazio’s Phone: (225) 241-9823
Warren Dazio’s Email: daziow@costsegserve.com
Cost Segregation Services: https://www.costsegregationservices.com/
179D Commercial Buildings Energy-Efficiency Tax Deduction
Tangible Property Regulations with Toby Mathis and Kevin Jerry
Anderson Advisors Tax and Asset Protection Event
Full Episode Transcript
Toby: Hey guys, this is Toby Mathis and you’re listening to the Anderson Business Advisor Podcast. Today, I have an expert. I love tax experts and good people. His name is Warren Dazio. Warren, first off, welcome.
Warren: Thank you. I appreciate you having me, Toby.
Toby: Warren’s down in the good state of Louisiana.
Warren: I am.
Toby: I have a brother who’s down in your neck of the woods, so I can always appreciate it. I’m happy to have you.
Warren: That’s right. It’s crawfish land and lots of other things. We have a good time here.
Toby: Yup. You got the Saints. I hope you’re a Saints fan.
Warren: Absolutely, and an LSU Tigers fan. It’s hard not to be an LSU fan this year.
Toby: They put it on them. Oh my God. Nobody can touch them. Anyway, we’re going to jump into tax because we love tax. Why don’t you give a thumbnail sketch of what you do, and today we’re really going to be focusing on self storage. I just want to give a little bit of background on who exactly everybody’s listening to.
Warren: I’m the Executive Vice President of CSSI, Cost Segregation Services Incorporated. We are an engineering-based consulting firm, and we focus on the tax law that surrounds a commercial building. It’s primarily the tangible property regs that came out in 2014, tax reform that came out in 2016, and our bread and butter that we’ve done for the longest is cost segregation. That is basically accelerated depreciation on a building to reduce your income taxes.
Toby: You guys do it all, which we appreciate. From a tax standpoint, I always love 179D. I love the tangible property reg simply because for those who aren’t into these things, there are certain types of expenses that you take and never have to worry about ever again. And then in real estate, quite often you’re taking an expense like depreciation where you have to worry about recapturing it at some point. There’s just some really tricky ways about how to be classified as one versus the other.
I’m sure we’ll jump into that, and then the 179D is the tax credits. Tax credits are like dollars in your pocket, so I want to hit on all of those today. But I specifically want to dial into an area that seems to be a favorite for a lot of investors, which is self storage. Is this something that you’ve been dealing with for a while or that you’ve been watching over the last few years?
Warren: I have. I attend all the national self storage events in Vegas and various parts of the world and get a lot of state ones. I’ve spoken at some of the national events. Self storage is a great candidate for all the things that we do, whether that’s TPR or cost seg, and sometimes 179D as well.
Toby: Have you seen a big push on it? Here’s my thing. I was looking at it as tenants can be a pain in the tush. Anybody who has tenants, whether it’s commercial or residential—it doesn’t really matter, you’re still dealing with somebody. And that seems to be gone when it comes to self storage. Is that what you’re seeing?
Warren: Yeah. People still deal with tenants, but there’s so much now that’s automated, and there’s so much now that they can do and not have to deal with those tenants. I’m definitely seeing self storage as a massive, massive industry and massive […]. I’d almost say it’s at the top of its game right now.
You’re seeing the cap rates very high, and you’re seeing lots of the smaller guys sell out to syndicates, REITs, and things like that. It’s prime real estate right now. And from a cost seg standpoint, it’s through the roof—the benefit that we can bring from what we do to a self storage […].
Toby: Absolutely. I’m seeing the same thing. I follow my clients and I see what they’re doing. I see the syndicators, I see what they’re doing, and they’re all looking for these. There’s not a lot out there. They’re having to build, or they’re having to convert. Speaking of that, do you have a preference? From a tax standpoint, are you seeing one versus the other being more beneficial?
Warren: Yeah. Let me give you a couple of examples. We’ve got a client that owns eight facilities that converted. They’re picking up a big box of Walmart, Kmart, or whatever. They’re converting that into a climate-controlled self storage facility. When they do that, they’ll call us and say, hey, can you run the numbers for a cost seg? We’ll do that for them and they’re getting massive, massive deductions from a cost seg accelerated depreciation on that self storage facility.
They’re taking things like interior door partitions. Pretty much when you have a shell like that, a large majority of what you’re going to put on the inside is going to be a 5-, 7-, or 15-year asset that they can accelerate. That’s a great candidate. Another great candidate is a build-up from the ground up. We’re seeing what you’re running into is some markets are saturated, the smaller markets are not, so they’re building ground up.
What I’m seeing is you’ll see an owner go and do all the legwork and get all the permitting done. As soon as they open their doors, some of the big guys are stepping in and saying, hey, we’ll buy you at a premium now that you’ve done all the hard work. A new purchase is great for a cost seg. Conversion is great for cost seg. A little bit less—you’re going to get a higher return on a climate-controlled versus a non-climate controlled as far as cost seg goes.
What they’re doing is just the 32nd version of cost seg is they’re accelerating portions of the building that offsets their taxable income, and the end result is reduced taxes. That flows from the entity to the individual’s K-1s or the individual’s returns. They see a reduction in income taxes by applying a cost seg for their self storage facility or any kind of property […] building.
Toby: A lot of my listeners know what cost segregation is. The bird has been chirping on it for years. But what it boils down to is if you have a commercial building a 39-year property, if it’s a $1 million of actual improvement, you take the land out. Let’s just say it’s $1 million, you’re dividing it by 39. That’s the default. That’s if you’re doing the straight line. If you make a change of accounting election and say, hey, I’m going to break it into components, and then you use an engineer or a really good company like yours.
You break it into pieces, and usually, about a third of it—or somewhere around there—is going to be 5-, 7-, or 15-year property. What that means is you can write it off quicker, or you just take them to the Tax Cuts and Jobs Act. They give this 100% bonus depreciation, boom. You can take about $300,000 in year one and write it off. It’s still passive activity, so some people get to use it and some people don’t. But what we know for sure is you’re not going to be paying any tax on that income for a long time because you’re going to be offset.
Besides the cost seg, there are also tax credits, which are like cash that is available in these?
Warren: Yes and no. 179D is I think what you’re thinking and that is the deduction as well. Research and Development is a credit for credit (as far as it goes). And there’s another one called 45L that’s associated with residential rentals and that’s a credit. 45L, R&D are credits. 179D is a deduction, and self storage can qualify for 179D.
Toby: 179D is there a dollar amount that you’re going to get per square foot or something?
Warren: Yeah. It’s anywhere from 30¢ – $1.80 per square foot. And the three areas that they focus on are the building envelope, so your roof, your walls, your windows, the insulation that you have, what […] you have, and the envelope. Then they have HVAC, and of course, that’s going to be heat or air. You can do heat pumps and tied into that is a little bit of water. Envelope, HVAC, and then LED lighting. Those are the three areas.
In conception, if you did just an LED lighting project, you would get up to 60¢ per square foot. But if you had new construction and pretty much all new construction now qualifies, you’re going to get a full $1.80 per square foot as a deduction. How does that equate? You get a $100,000 deduction, multiply that times the 37% tax bracket, and you get a $37,000 reduction in your taxes is how they […].
Toby: Is that subject to recapture and everything else just like the others?
Warren: I think 179D. I don’t know the answer to that. There you go. Stump the chump. You got me, Toby.
Toby: I’m just looking at how it gets recaptured. If it’s an expense, then it’s either going to be an expense that you don’t have to recapture. This is just a bonus. This isn’t something that’s offsetting the balance sheet item, or is it?
Warren: Gains are under other deductions on your tax return. If it’s a deduction, I would assume it is subject to recapture.
Toby: Possibly. Well, something that we can play with. I didn’t mean to do that to you.
Warren: I can because you give me homework. You make me go and learn the right answer and that gives the listeners a reason to call me back.
Toby: I know that the tangible property regs, you don’t have to recapture. I know that bonus depreciation you do, and so I’m just like, hmm, what is the other?
Warren: The difference in that too is the tangible property regs are in what’s called a partial asset disposition. You’re writing off something and expensing it outright with 179D, cost seg, and bonus depreciation as a deduction. It stands to reason that it is subject to recapture.
Toby: It would be subject to recapture, yeah. Let’s say you get a $1.80, are you using that against the value of the property, or is this just an extra deduction that you’re getting almost like a bonus deduction?
Warren: Yes, you’re using it against the basis of the property.
Toby: That it would definitely be subject to recapture, I would just say. I guess we’ll play around with that one. What else is there that’s out there in our toolbox that we can play with regarding self storage? I know there’s just probably a whole bunch of things that you can do when you’re building these things up that if you do it right—since you’re building it, or if you’re doing a modification—you’re able to get some major tax relief.
Warren: You probably already covered the TPRs and all that’s associated with that. You might have covered the partial asset disposition. For example, if you have a building in service as a self storage facility or anything else, and you decide after a period of time, hey, I’m going to do a renovation. You tear some parts out and put new parts in, and then there’s a benefit associated with that. You’ve thrown an asset away and put in the trash.
Toby: Explain that one out because that’s huge. I want to hear you go through it.
Warren: Let’s do doors or lights. We have those clients. We had so many clients call us that said, hey, we’re doing LED lighting retrofits. Is there any tax benefit from that? And it’s a double whammy. The first thing is the partial asset disposition. Let’s say you own the building for 10 years, and you’re tearing out the existing lights with your typically a 39-year asset throwing those in the trash. You had it for 10 years. The LEDs are a 39-year asset. Get 29 years of value that you can now write off, and you can write off the labor to remove it, the asset itself, and the disposal cost. A pretty big number.
At the same time when you’re doing that, you could potentially qualify for 179D. In addition to writing off the basis, which is an expense write off, not a deduction write off, you’re able to possibly get 60¢ per square foot on the 179D deduction. You can do two things, and that’s part of what we do for our firms. Doors, for example. You got your doors. What you probably talked with Kevin Jerry on a prior one was if you replace it in the third or less of the doors, you can expense it.
Let’s say you’re doing all the doors the same process. Exterior doors are a 39-year asset. Interior doors are a 5-year asset. If you’re placing the exterior doors, and you’ve owned the building for 10 years, you’ve got 29 years of value you’re thrown in the trash, so you can write that off. It adds up to real dollars.
Toby: If you break it down. You have to break this stuff down, right?
Warren: Correct. You got to pay attention to what you’re doing. If you go ahead and do what’s called a partial asset disposition, we also call it PAD. If you’re going to do a PAD and then you don’t capture that in the same tax year, you can go back and capture the benefit. If you’ve got clients that are doing renovations or improvements, ask those questions. Hey, is there a PAD available? Have you talked to your CPA about it? If your CPA is not aware of it, call a firm like ours and help you quantify that and put a dollar amount to the write off you can gain from it.
Toby: You’re hitting something on the head right there, by the way. Most CPAs, they’re aware of some of this but unless they deal with this day in and day out, chances are they’re not. Even if they are aware of it, they still have to engage a company like Warren’s to actually do the numbers. CPAs are not qualified to do this work.
Warren: A CPA would be qualified to do an air conditioning unit, a single line, or a roof. When you’re starting to pull out partitions and doors, that’s when you call us in. I will never fault a CPA because they’ve got to learn thousands and thousands and thousands of aspects of tax law. We focus on the tax law that surrounds a commercial building, and so our best partners are CPAs. They’ll call us and say, hey, I got a client who’s doing some improvements. Can you capture qualified improvement property?
Can you capture a bonus? You can capture Section 179, which is a little different within a 179D. Section 179 and bonus are similar. 179D is the energy piece. That’s a great point. We partner with CPAs. I’ll always say they can do one or two assets, but when it gets down to tearing out big chunks, that’s when they need to call […].
Toby: When you’re doing a cost seg, again, I wanted to focus on self storage. If you’re doing a cost seg, you need the engineers. If you’re doing a brand-new build, it’s easier because you actually have the invoices from the contractor. You can break it down much easier, but if you’re buying something, you need an engineer to go through it, and the IRS is going to say is that a qualified individual that did the report, right?
Warren: Absolutely. There are different types of cost segs that are out there. The gold standard is the engineering-based method. I call it a certain method. This is what the term the IRS uses. It’s going to capture both from the accounting standpoint—the dollars that are on your receipts, as well as a construction standpoint. Engineering firms marry that together.
The IRS also uses terminology like you should use a third party non-related firm to do it. The CPA has some incentive to gain you more savings. The government says it’s best to have a third party firm do that.
Toby: Absolutely. You want to have quality. There is a software floating around out there that people are starting to use. The software is going to be very conservative. This is just a complete aside, there’s a difference between price and value. You want to actually look at the value. Don’t buy things on price. Buy things on the value that you’re receiving. A qualified individual is going to get you a much higher deduction. As you’re probably hearing, there are different types of deductions.
There are deductions that you recapture, there are deductions that you don’t, there’s 179, there’s bonus depreciation, and there are flat out expenses. They’re all different. You use a qualified professional so that you can make sure that you’re not hurting yourself, and that you’re getting the maximum benefit. You get it. It’s about value. I’d much rather spend $5000 to get $50,000 of a benefit than spend $500 and get $1000. It’s not even close.
Warren: To support that, what happens if you’re audited? A firm like ours, we’ve done somewhere in the neighborhood of 22,000 studies.
Toby: 22,000 studies?
Warren: Yeah. We have been around for almost 18 years. We’ve never triggered an audit, but we’ve had to step in and represent clients who were audited for other reasons in about a dozen cases. All of them end with a happy client and happy IRS. If you’re using software, who’s going to help you represent it if you’re ever audited?
Toby: That’s exactly right. They always say that they’ll represent, but they didn’t do the report. How do you represent something that doesn’t exist? The computer shows up and starts trying to talk. That’d be a fun day. Let’s go back to self storage because that’s where we started. Is there anything else that you’re missing? Is there anything else that somebody else should be looking at? If they’re going into this realm, are there any other little tricks that you got up your sleeve that might be able to help them?
Warren: Tangible property regs help you expense more. Partial asset disposition writes off when you’re doing a renovation. Cost seg helps you accelerate depreciation. If you do indoors or LED retrofits, it’s smart to do a partial asset disposition, and then also maybe chase down 179D. I think we’ve covered most of them. That’s five or six items that we can throw out there and say these are important tax strategies that you guys need to be aware of.
Toby: Absolutely. Let’s talk about the really important stuff. If somebody is doing one of these projects, how do they get a hold of you? I know we’re going to put a link up, but if they just want to reach out to you, how do they get ahold of you?
Warren: My direct line is (225) 241-9823, or you can follow the link that Toby’s going to provide for you. The best way—you can email me. My email is a little harder. It’s daziow@costsegserve.com.
Toby: We’ll put all that up so that they don’t have to try to write it down. A lot of people listen to this on a podcast. Is there anything else that you want to throw in there? Here’s a fun one. If you don’t have anything else, I’m going to ask you a question that’ll prompt it.
Warren: You can ask me a question. But for me, a firm like mine, we want to coach a building owner to expense as much as they can on the front end—and we use tangible property rights for that. Then when they can’t expense anymore, we’re going to do cost seg and bonus or Section 179. Then if they’ve made energy-efficient improvements, we’re going to chase down 179D and even Research and Development—R&D credit.
That’s our mindset and our mantra. Our mantra is not to push a cost seg on someone. Our mantra is, have you expense as much as you can expense first, and then when you can’t expense anymore, then we’ll cost seg, PAD, or bonus benefit you. We do the same thing with a CPA. We get CPAs that are not quite as familiar with the tangible property regs, and we’ll walk them through the same process. We want to be a consultant for them, find all the right answers for them, and make the right fit. It’s always a time […].
Toby: What I’m saying is—just to make sure it’s crystal clear—when you’re doing tangible property regs and you’re writing your expensive things, that is no longer subject to recapture. For property owners, that’s the holy grail. I get to write it off and I never have to worry about having to recognize it as depreciation recapture, as long term capital gains—nothing. I wrote it off.
When you go into the cost seg 179, 179D, you’re talking about expenses that would be subject to some form of recapture, either as ordinary income or subject to depreciation recapture, which is capped at 25%.
Warren: Right. And the things you expend you never see again. The things you have to capitalize on that are subject to recapture go on your depreciation schedule and you carry it over time.
Toby: Yup. There’s a big difference. Now I really like to ask this question, which is if you can go back in time and you found yourself when you were 16, what kind of financial advice would you be giving? What would you tell them to invest in?
Warren: If I was 16, what would have I told them to invest in? Exactly what we’ve been talking about. I’ve seen self storage owners just crush it. Warehousing self storage owners. I was talking to a very good developer and building owner out of Dallas one time and I said, what are some of the best advice you can give? He said, people always want me to build the go in with them on these big high-end office complexes. He said, when the economy starts going south, it’s warehouses and self storage facilities that are still killing it.
He’s diversified. He’s got a couple of nice offices, but he’s got quite a few mobile home parks, self storage facilities, and warehouses. You ask somebody who’s 16, once you get to the point where you can save up a little money, you’re probably going to be able to afford a warehouse over an office building or anything like that as well. Think about the type of investment you’re going to go in. For a 16-year-old, start saving now and invest your money. Put it to work. Don’t burn through it like so many of us young people want to do.
Toby: And don’t get a $300,000 English degree. Hey, that’s fair enough. I really appreciate your time, Warren. I’m just glad that you were able to come on.
Warren: Thank you, Toby, very much. And all your listeners out there, keep listening to Toby’s podcast. He has good stuff. Hopefully, you’ll be hearing this on a Tax Tuesday at some point.
Toby: We love Tax Tuesday. All right. Thanks, Warren.
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.
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