Tax Strategies for Real Estate Investors

Aviva (00:02.009)
This week's listener of the week is Allison Sands. Allison, thank you so much for leaving us a five star review. And for those of you listening, if you leave us a five star review below, you might be next week's listener of the week, week.

Today on Commercial Real Estate Secrets, the podcast, we have Eric Oliver hailing from my neighboring state, Utah. Eric, how are you doing today?

Erik Oliver (00:32.382)
I'm good, I'm good, thanks for having me.

Aviva (00:34.445)
Yeah. So Eric, tell us who you are, what you do, and what, how'd you get here?

Erik Oliver (00:41.946)
Sure. So my name, as you said, is Eric Oliver. I work for a company called Cost Segregation Authority. We work with investors, real estate investors, CPAs, tax attorneys, tax professionals across the country, helping reduce tax liability for their clients who own real estate. My background is in accounting. I never went and got a CPA license. My

Background is only in accounting because that was the quickest easiest way for me to get out of college And so I hated writing papers. I'm not good at English. And so I'm like, okay, how do I get out of this place? well math always came somewhat easy and so Got my degree in accounting and then went off and had a couple careers doing business development sales type jobs moved to New York and Born and raised in Salt Lake moved to New York for a number of years I was looking to come back to Salt Lake and I came across this job at cost leg authority

Didn't know what cost segregation was like most of us. I had heard the term but wasn't real familiar with what it was. And looked into it, thought it was a great fit. I've always been interested in real estate. Like I said, tax and numbers have always come somewhat easy to me. And so ended up taking this job about seven years ago. Loved it. Loved working with investors to try and reduce tax liabilities. So

Aviva (02:02.894)
Well, thank you for being on the show today. So for the listeners, can you explain what cost segregation is?

Erik Oliver (02:14.09)
Yeah, cost segregation really is just accelerated depreciation on your real estate assets. So one of the great benefits of owning real estate is you get to take a depreciation expense every year on your real estate. Now normally that depreciation expense is either over 39 years for commercial property or over 27 and a half years for residential units. So let's just make the math easy. Let's say I buy a single family rental for $275,000.

Essentially, I would take that $275, divide it by $27.50, and I get a $10,000 write-off every year for the next 27.50 years. Now, I've oversimplified that a little bit because land is non-depreciable, so you always have to back out your land value. Just for the listeners, to give you the idea, you get that $10,000 write-off every year. Now, that comes off of your taxable income. So, let's say I make $100,000 a year. Instead of being taxed on $100,000...

Now I'm only taxed on 90,000 because I've got this $10,000 write-off that comes off every year. So that's called, that's depreciation. Now cost segregation is accelerating that. I might not own my property for the next 27 and a half years. I want my deductions now versus getting an even amount every year for the next 27 and a half years. So the way we do that is through an engineering-based study where we come in. When I bought...

my single-family rental. I didn't just buy the land and the walls. I also bought some cabinets. I bought some countertops, some appliances, some driveway, some concrete, a retaining wall, a fence, irrigation system. All those things I mentioned should be depreciated over a faster rate than 27 and a half years. But the problem is, is I buy my property, I give my closing statement to my tax preparer, instead I paid 275 for it.

neither of us know what the value of the asphalt is or what the value of the carpet is in the building. So a cost segregation comes in just as the name implies. We segregate that cost into different buckets. For example, carpet should be depreciated over five years. So we put a value to that carpet and now we get to write that off over five years versus 27.

Aviva (04:29.945)
Sounds like a lot of math in your day to day. And that is coming from somebody who has quite a bit of math in my day to day. So are you, when you do your cost segregation studies, are you literally breaking down the property that literally into these buckets that are, like you're saying, fencing, appliances.

Erik Oliver (04:32.156)
I'm sorry.

Erik Oliver (04:51.118)
Exactly. Yes. Yes, we are. So we're going in and we're identifying, putting a value because again, a fence, for example, the IRS says a fence doesn't last 27 and a half years, it lasts 15 years. And so if we can say that you've got a $10,000 fence, now we can say, okay, well that fence should be depreciated over 15 years, not 27 and a half. And so yes, that's exactly what we do is we go in.

We basically reverse engineer the building and break it up. You know, it's easy when you build a new building, you have a price of the fence, you've got a price of the carpet, you've got a price of the countertops. But when you buy an existing building, you don't always have that information obviously. And so that's really what we come in and do is provide the, how much fencing, what the value of the fence is, so that you and your tax preparer can then depreciate it over the correct useful life.

Aviva (05:43.029)
Okay, I'm going to say something that you might think is funny, or maybe you won't think it's funny at all. But I am a commercial real estate broker, and I have people who reach out to me and they say, you need a cost seg person for your transactions. And then I gloss over and you check my Instagram. How could a commercial real estate broker like myself use a cost segregation professional

Erik Oliver (05:47.854)
Hehehe

Aviva (06:12.617)
in our transacting in a way that would benefit our clients.

Erik Oliver (06:17.554)
Oh, that's a great question. So one thing that I always like to share with commercial real estate brokers is anytime a client comes to you and says, Hey, I've got a building for sale. I want you to help me sell my building. One of the questions you should ask is have you done a cost seg study on that building? The reason being that when you do a cost segregation study, even if you do it right before you sell the building, there may be an opportunity to save significant tax dollars and all.

I'll kind of back into this example because I think it makes a little more sense. But let's say I bought my building five years ago for a million and I come to you now and say, hey, I'm ready to sell my building. It's been five years. It's doubled in value in the market. It's now worth two million. I want to sell my building. Well, if you sell that building and you don't do a cost-seg study, when you go to settle up with the IRS, you're telling them that everything is doubled in value.

I bought my land for this, I bought my walls for this, I bought all the stuff in this building for a million, I'm now selling all this stuff in this building for two million, so everything's doubled in value and the IRS charges you tax on that. Well, the land has gone up in value, the walls have gone up in value, but certainly the dirty nasty carpet that's five years old isn't worth double what you paid for it five years ago. But when you don't have the carpet broken out and you don't know the value of the original

then all you can do is say, hey, I just bought this lump sum of stuff for a million. I'm selling this lump sum of stuff for 2 million and you get taxed on it. And what you should do is you shouldn't sell your carpet for more than you bought it for. So you get to pull your carpet out of your transaction and it creates a permanent tax savings. So in summary, you're taking your deduction at a high rate. So I'm taking my deduction against my ordinary income.

paying some of it back at a capital gains rate and saving the spread. So there's a rate arbitrage that you should be taking advantage. And if you sell your property and file your taxes and you don't do a cost seg study, you lose out on that permanent tax savings.

Aviva (08:22.433)
Wow. So, are there additional benefits besides tax savings for utilizing cost segregation on a property?

Erik Oliver (08:36.386)
There are. So, well, I wouldn't say additional benefits other than tax savings. There's more, there's multiple opportunities to save tax dollars by doing cost seg. One is you get the time value of money. You're getting all that savings now versus in the future. That's the first thing. The second thing is what we mentioned about the reduction of recapture tax upon sell. And then there's a third one, which is the ability to take what we call partial asset disposition. So,

Let's say I buy an office building and I do a cost-sake study and they put a value to all my different components. So now I've got everything broken up on my depreciation schedule. When I go to replace the roof on my office building, I'll have a line item on my depreciation schedule that says old roof. I can pull that number off my schedule when I dispose of my old roof and then put the new roof on my schedule and start depreciating my new roof.

when it goes into service. And what we see happen all too often is you'll see a depreciation schedule that'll say building a million dollars, and then two years later you go put a new roof, and so the next line underneath the building says new roof, 100,000. Well now I'm depreciating two roofs at the same time because stuck in this line that says building is a roof. There's part of that building value is the roof, but we don't know the value.

So we just leave it in there. Now we're depreciating two roofs at the same time. And what that unintentionally does is it creates a larger recapture tax upon sale. So without getting too far in the weeds, you basically are paying more tax by doing it that way. And so having everything line itemed on your depreciation schedule, as you replace stuff, pull the old stuff off, dispose of it, write it off as a partial asset disposition, and then start depreciating the new items.

Aviva (10:30.357)
So say you own one residential property, that's a rental. Is it advantageous to do cost segregation on one property?

Erik Oliver (10:44.37)
That's a great question. If you would ask me that seven years ago, I would say no. However, back in 2017, 2018, there was the Tax Cuts and Jobs Act. So this was Donald Trump's tax overhaul. As you can imagine, Donald Trump owns real estate. Donald Trump, when he revised the tax code, made it very favorable to real estate investors. So in that tax overhaul, there's something called bonus depreciation, which has been around for a number of years.

Aviva (10:48.492)
Hmph.

Erik Oliver (11:12.078)
However, they increased bonus percentages with that Tax Cuts and Jobs Act, and it basically put cost segregation on steroids. And why that's important is cost segregation used to really just apply to your large institutionalized investors. You know, if you're buying hotels, casinos, hospitals, those types of things. With bonus depreciation, the benefit went up dramatically.

And because it went up, a lot more people were able to take advantage of it, which caused a lot more competition in the industry. So prices went down, benefits went up. And so now doing cost segregation on a single-family rental absolutely makes sense in most cases. I would say if your single-family rental was purchased for anything greater than about $250,000, it's probably worth looking into to see if you can save some money by doing a cost segregation study. So...

Now most companies will do a free benefit analysis where you give them a little bit of information and they can tell you, hey, based on that information, we're gonna save you 80,000 in taxes. The study's gonna cost you 3000 to do it. And then obviously you make that decision with your tax preparer. But definitely worth looking into even on single family rentals.

Aviva (12:26.309)
So I think that'll be valuable for a lot of our listeners who are newer investors and what better way to approach, you know, most people approach real estate investing with that first house. So, but on the other end of that spectrum, I wanna ask a scenario. So say you own a $10 million apartment complex. Round numbers, 20 units.

Erik Oliver (12:39.915)
Right.

Erik Oliver (12:45.326)
Sure.

Aviva (12:53.713)
Okay, 20 toilets, 20 dishwashers, 20 of it all. Now we have a $10 million warehouse.

couple garage doors, couple HVAC units, same cost of a property. What is the difference in cost segregation between what some might say would be the most, one of the more complicated asset classes, multifamily, versus an asset like warehousing where it's pretty simple in terms of fixtures on the inside?

Erik Oliver (13:30.014)
Yeah, so the kind of the range is kind of the average. I'll just give you an industry average and I'll kind of break it down. But industry average is usually around 30% segregation. So you've got a $10 million asset. We're usually gonna go in and find about 30% of that or $300,000 that should be reclassified into different buckets per se. That's an industry average. Now,

An empty warehouse, you might get 20 to 25%. And usually it's not a lot of inside stuff. It's usually the 20 to 25% is mostly outside stuff. Things like asphalt, concrete, curbs, gutters, trees, bushes, shrubs, fencing, lighting, all that stuff is what we usually get on a warehouse. Now there will be some stuff on the inside, but not a lot. So usually 20 to 25% on warehouse versus multifamily, we're probably gonna get somewhere to.

closer to 35% because of what you stated. We've got multiple dishwashers, multiple appliances, ceiling fans, garbage disposals. And so multifamily is a great asset category. So usually with a few exceptions, you're probably somewhere between 20% segregation and 35 to 37% segregation. I've seen as high as 40 in some rare instances. There are a few unique categories.

Aviva (14:47.534)
Wow.

Erik Oliver (14:51.234)
that we should note, one is car washes. If you think, I don't know about Denver, actually I do know about Denver, because I was in Denver a few weeks ago, car washes are popping up there, just like they are here in Salt Lake. Car washes are a unique asset class. If you think about it, when you buy a car wash, all you're buying is land improvements, things like curbs, gutters, asphalt, and then you're buying some equipment. And all those things are short-term assets, which means they're all eligible for bonus.

So it's not uncommon to spend a million dollars on a car wash and get an $800,000 write-off in the first year, or 80%. A couple of years ago, it would have been 100% when we had 100% bonus. This year, in 2023, it dropped to 80%. 2024, it drops to 60%. With one caveat, I'll punch on that real quick because it's important. There is a bill in Congress right now that has passed the House.

Aviva (15:37.271)
Interesting.

Erik Oliver (15:45.546)
to extend the 100% bonus through 2025. So hasn't passed the Senate, but they're gonna retro date it back for the 2023 tax year. So they've got to make a decision really quickly because people are already starting to file their 2023 taxes. Has bipartisan support, both sides of the aisle want it. I don't see why it won't get passed, but my guess is in the next two to three weeks, we should hear that 100% bonus will get extended through 2025. So.

In that car wash example, you buy a million dollar car wash. If all those things are short term assets, that whole million dollars, then you can take 100% of that whole million and you're getting essentially $100,000, or excuse me, a million dollar write-off in the first year. So car washes are unique. Mobile home parks, you think about mobile home parks. If you buy a mobile home park, if you're not buying any existing trailers, you're just buying the park, you're buying cement, you're buying...

pads, cement pads, you're buying trailer services, you know, the water, the sewer, the electrical, and that's all you're buying. And so those are all land improvements, all eligible for 100% bonus. So mobile home parks are unique. And then the third one would be gas stations. Gas stations kind of have their own unique depreciation life. Even if you've got a convenience store attached to it, oftentimes the whole gas station gets reclassified as a short term asset and is eligible for bonus. So

Aviva (17:12.301)
You are blowing my mind right now.

Erik Oliver (17:14.981)
If you've got a lot of income, go buy a gas station or a car wash and you'll knock out all that income.

Aviva (17:19.902)
I know I have this one friend client. I'm like, I literally actually thought to myself, I was like, I'm calling him the second we're done with this and telling him he needs to buy a car wash.

Erik Oliver (17:28.79)
Yes, it's not a con. We work with a lot of investors, actually the owner of our company, but at the end of last year, bought a car wash just for that reason to take advantage of bonus. He's actually going to knock the car wash down and build multifamily in the next coming, in the coming year. But in the car wash wasn't even cash flowing. I mean, it was breaking about even, but he was buying it simply for the tax write off, saved himself a couple hundred thousand dollars in taxes. And now

He'll just scrape it and build multifamily and be able to take advantage of the depreciation on that.

Aviva (18:01.425)
This is, that is so cool. That fact made my whole day. So, I'm gonna ask you a selfish question. My family, our strategy in real estate is buy, hold, never sell. Great strategy. Thanks, grandma, grandpa. Appreciate it. But I still broke her day to day. I was talking to a client and he said,

Erik Oliver (18:10.05)
Sure.

Erik Oliver (18:16.494)
Okay. Yep.

I'm going to go to bed.

Aviva (18:29.197)
our depreciation schedule is up and we're selling. Can you, and that was something I had never heard before. Can you explain the strategy behind what he said? And yeah, yeah.

Erik Oliver (18:42.506)
Yeah. So yeah, your depreciation, if you hold the building, let's say you hold a multifamily. So multifamily gets depreciated over 27 and 1 half years. Let's say you've owned that property for 30 years. You're getting no tax write off on that property anymore. So in some cases, it makes sense, depending on, well, there's a lot of other factors. But in some cases, it makes sense to sell that property, either 1031 exchange into a new property.

Or just outright buy a new property so that you have new basis That you can start depreciating again. So that's one strategy is once you know, some people especially with this bonus depreciation They'll they'll hold the property five to seven years take all the write-off take these big deductions and then sell it and then get another Property take all the deductions and then sell it but in most cases it's What is the analogy or the terminology? It's a

Exchange exchange, what do they say? I work with a guy who's a 1031 expert and he's got a saying, basically exchange it till you die, I can't remember. Anyways, basically exchange, and then unfortunately we all pass away. When you pass away, your estate gets a step up in basis and nobody pays tax on it. So there's really two ways to do it. You can either exchange or you can just keep buying new properties, creating new deductions, as long as you're purchasing properties at a higher dollar value.

Aviva (19:50.28)
Ha ha!

Erik Oliver (20:08.854)
But yeah, a property that's paid off that you've had for 30 years, yes, it's probably cash flowing, but from a tax benefit perspective, you're not getting some of that depreciation that you would get if you were to sell that and get into a new property.

Aviva (20:24.089)
Wow. Yeah, that was just a new way to look at it that I had never considered before. And I love learning different strategies and ways to attack it. So are there any important considerations or challenges that investors need to consider when undergoing the cost seg study?

Erik Oliver (20:35.01)
Yeah.

Erik Oliver (20:47.774)
Yeah, so it's not for everybody. I'll start by saying cost segregation. When we do cost segregation, the deductions that we create are usually considered passive deductions. And so you need to have passive income in order to offset those passive deductions. Myself, I'll use myself as a live example. I am a W2 employee here at CostSeg Authority. I have some rental properties on the side.

If I do a cost-sake study on my rental properties, I cannot use those deductions to offset my W-2 income. I can use them to offset my other rental income or other passive income, but not my W-2 income. You want to make sure, just because we can create a large deduction, doesn't mean everybody can use it. I imagine a lot of your listeners have probably heard of real estate professional status. If you are a real estate professional by trade, meaning you do that for a living, you're

The IRS has kind of a unique definition. You have to spend 750 hours a year doing real estate. That's the easy test. The harder test is you have to spend 51% of your working time doing real estate. So I'm a 40-hour-a-week guy here, so I can't go. The IRS isn't going to believe me if I tell them I'm spending 41 hours a week doing real estate, so I don't qualify as a real estate professional. But what we see is a lot of times you have high W-2 earners where.

Maybe their spouses gets to stay at home and they become the real estate professional. They manage the properties. Now, in that case, if my wife was a real estate professional and we file a joint tax return, then now I can use the deductions from my real estate to offset my W-2 income. So that's kind of the golden ticket. If you can get that real estate professional status, the tax laws change a little bit. But...

So that's the first thing, you want to always make sure that you have enough passive deductions, excuse me, passive income to utilize those passive deductions. That's a, it's not for everybody, but if you can, it can create huge, huge tax savings.

Aviva (22:49.657)
Wow. It's super interesting. I think we're going to bring a lot of value here for people.

Erik Oliver (22:52.894)
Yeah. I'll just add one thing on that. I've known a lot of high W Touriners where maybe their spouse worked a part-time job and they've looked at the numbers and said, you know what, honey? You can stay home, become a real estate professional and we're gonna save so much money in taxes that it's gonna be more than what you were making at your job. And so just by making that one switch, they've been able to semi-retire basically and still they'll come out ahead.

Aviva (23:13.425)
crazy.

Aviva (23:23.725)
That is nuts. I've got two more questions for you. So the future of cost segregation and technology, where do you see it going or how do you see it changing and evolving?

Erik Oliver (23:28.014)
first.

Erik Oliver (23:39.138)
That's a good question.

Erik Oliver (23:43.906)
That's a great question. So I've already seen it evolve even in my short time. I've been doing this for seven years. And you know, cost segregation, there's no governing body out there. Anybody can do cost segregation. You could go online right now yourself, go to a couple of websites, put in some information and pay a couple hundred dollars and it's gonna spit out a report. So I think technology has its place. However, I do think that we're always gonna be needed because

One, the IRS doesn't want you putting in information on your own building because not that they don't trust you, but you might be super aggressive in what you say. I trust you, but the IRS might say, hey, you know, you said that your building has all carpet. Yeah, I don't believe that you have carpet in the bathrooms in the kitchen. I don't think that's the case anymore. So I think when people use technology themselves, there's area for manipulation. I don't know if that's the right word, but the IRS wants

They want somebody, a third independent party, who says, Eric has no reason to lie about how much carpet's in your building. He has no value in it. He has no stake in it. So it's a trusted source. So I do think that the technology is there. But I think there's always going to be that element of having a third person verify the information, especially on these cost segregation studies when you're talking about tax savings. Because again, the IRS just doesn't want to leave it up to you. Because you may be.

may be super aggressive in your findings.

Aviva (25:14.681)
Hey, I see it the same with brokering. It's like, you don't need me, but you probably want me because I'm gonna make this a lot easier for you. And a robot can't. Ha ha.

Erik Oliver (25:22.445)
Right.

Yeah, exactly.

Erik Oliver (25:29.834)
Right. Not yet they can. I'm not saying they won't be able to, but not yet they can, especially in the cost seg world.

Aviva (25:36.685)
Yeah. So my last question I asked to everybody, what makes you happy as a result of what you do in cost segregation?

Erik Oliver (25:48.778)
Yeah, you know, I'm all about paying our fair share of taxes. I don't want anyone to ever cheat. You know, we all need to pay taxes. And so I never thought that I would be in a job where I was getting people out of paying taxes. But now that I know and understand the tax code a little better, the government uses the tax code to incentivize people to do what they want them to do. So.

People who go out and buy buildings, who create business, who make transactions, they are, it's helping the economy. It's helping people all along, all along the way. And so, um, one of the most rewarding things for me to do is help people find ways that they didn't know they had. A lot of people own these buildings currently, and they've got all this, this tax savings that's just sitting there. They don't even know it's available to them. So I like nothing more than finding that tax savings, you know,

getting them a $200,000 refund check, and then watching them take that 200,000 and go buy or build more multifamily or go buy another duplex or what have you. So that's really the joy I find in what I do is being able to create opportunities for people who those opportunities are sitting there in a lot of circumstances, they just don't know they're available. So educating, bringing this stuff to the forefront has been great.

Aviva (27:06.785)
Yeah, I suppose when you create that opportunity for people, it gives you the, like it gives them more opportunity to create more opportunity and give back more to the economy and to uncle Sam. So amazing. I love it. Uh, Eric, thank you so much for being on the show today. If any of our listeners want to find you or contact you, what is the best way to do so?

Erik Oliver (27:15.318)
Right.

Right. Right, exactly.

Erik Oliver (27:29.471)
Absolutely.

Erik Oliver (27:36.906)
Yeah, the best way would be through our website. It's just www.costsegauthority.com. My contact information is on that website, my phone number, my email. You can also, if you've got a property that you think might be a good candidate for cost segregation, you can submit some information and we'll get you a benefit analysis, usually within 24 hours, let you know what our fee would be as well as what your potential tax savings would be. But...

Please use this as a resource, guys. We're kind of a unique accounting firm. We don't bill by the hour. We don't even do tax returns at our firm. So don't call me and ask me questions about earned business income or child tax credits, because I don't know anything about that stuff. But if you have any real estate questions about real estate tax, we're happy to help. We're happy to be a resource. Please use this as a resource.

Aviva (28:23.461)
Thank you, Eric, and thank you all for listening to Commercial Real Estate Secrets. We'll see you next week. Awesome.