So if you didn’t use a home office in your home exclusively for business, and then you don’t want to have to face the capital gain consequences when you sell, you would need to stop using that home office for business purposes for at least two years.
Hey simple passive cash flow listeners. Today we are going to talk about cost segregation and not for those looking to cost sick. They’re 200 unit 300 unit apartment complex. But how can we use this for our single family home rentals, smaller rentals or possibly even our primary residence? Again, this is the passive investing show simple passive cash flow, where we are trying to a lot of our highest and best use is that our date our day jobs, but how do we optimize things are investing so we can get out of the rat race and a lot of times I can see you guys getting out of it in less than five or 10 years. So today I have a cost segregation expert David Britten soul on the line. Thanks for joining us, David.
Yeah, so in the past year, I’ve kind of found that cost segregation studies are a little bit of a racket, a lot of companies and firms will do it out there typically charged around the same price. But there’s a difference between a legitimate cost segregation study. And one of those big things is actually having a site fitted visit, which David has actually flies out there himself, and he does these things. But yeah, can you expand on? I mean, there’s a lot of companies doing this, right, David?
Yes, there are in the last, I’d say 12 to 15 years is when a lot of them popped up. I’ve been doing this for 20 years. And in the first five years I was doing it, there was practically no one west of the Mississippi River that was doing it.
Yeah. And also on the smaller end, I mean, on our apartment projects, where it makes total sense with economies of scale and 100 200 300 unit apartment complex. But when you start to get into a single family home, like a lot of you guys will have $100,000 turnkey, it may not make sense. So there are some options out there that you might want, you can pay, you know, 400 500 bucks, and they do a little desk review. But David, can you talk a little bit to the legitimacy of those cost segregation studies and how those guys operate,
what they tend to do is they will ask you for the measurements of certain things that they want to segregate. And so essentially, you have to do it. And then you give it to them, and they’ll put it into a report. That’s the way I understand how they do it. We don’t do it that way. I actually go to the site and do the engineering myself, when it comes to these smaller projects, especially if there are new architectural drawings that we can use for the engineering.
And is there some kind of checkbox when you submit the cost segregation study to the CPA? Where, yeah, I actually did a sidewalk? Or is there any kind of designation that you need to do on your end?
Well, I do put it in the report that we visited the site. When I say we, it’s essentially it’s me, but I have an engineer who does the pricing on the value pricing of the assets that I bought segregated from studies where we don’t have blueprints. And also I photos, document everything. So when I’m on site, I’m taking pictures of all the components of the property that I want segregated, which obviously cannot be done if I don’t visit the site.
So you had out there, travel costs are included.
Do actually I did I build those separately on top of the stated fee? Right?
So you touchdown and what actually do you do on these trips to so people can get a sense of what goes into a cost segregation study?
Well, I mean, I have to look at the entire property both inside and outside. And so I photograph everything that I want to segregate. I measure everything I want to segregate in the case of situations where there are no drawings to work from. And that’s both inside and outside the house. And I have measuring equipment that assists me in doing that, such as the laser beam for the interior stuff and surveyors wheel for the exterior
stuff. If we kind of left people at the dock there what a case, cost segregation study is, but in a very high level, it’s a report that allows the CPA to now aggressively right off the property. Most single family homes you can write off a property and 27 years so 127 of the depreciate Over 27 years old, she called straight line depreciation row with a cost segregation able to aggressively write it off. Oftentimes, you can take one third of the entire building value in year one.
That sounds about right. In most cases, yeah,
you guys can check out simple passive cash flow.com slash cost sag, also embed this video in there too. But that’s pretty much the the guide to what cost segregations are. If you want to see how that ties into your own personal taxes, go to simple passive cash flow calm, slash tax. But let’s get into the good stuff, David. And before we do is throw down the disclaimer that you and I are not CPAs
I am a CPA.
Okay, you are? Yeah, cool. Well, I’m not one, and I’m not a tax attorney either. But we are just giving out infotainment here, right. We’re not giving any professional advice based on your personal situation, but just some ideas that have David has seen some of his clients do. And so let’s start off with the top right, like, can you cost segregate out and aggressively extract the depreciation on a primary residence that you want to live in? Let’s talk about that, that you cannot do,
you’re not allowed to depreciate your own home. The exception to that would be if you have certain areas that are used exclusively for business. But even then it may not be advisable to do that. Because if you are segregating out a certain portion of your home for business, a home that you own, because then when it comes time to sell the home, if you sell it again, you will actually have to deal with a capital gain on that portion of the home which might more than offset any deductions that you would have gotten for that area of of your home. That’s the one thing in the tax code is actually more of an advantage to renters and into homeowners, where a renter may use a bedroom in the two bedroom apartments. And we’re using exclusively for business, they can take all those deductions that are allowed and don’t have to deal with recapturing any depreciation because they didn’t take any depreciation because they don’t own it.
Now, what are some of your clients doing to do they turn it into a rental property or commercial property first, and then they move on after let’s talk about like, what are some folks that you’re seeing doing?
Yeah, you can do that. And what’s the way the law works is that as long as you lived in the home for at least two of the last five years that you’ve owned it, then it’s considered your principal residence. So if you did use a home office, in your home exclusively for business, and then you don’t want to have to face the capital gain consequences when you sell, you would need to stop using that home office for business purposes for at least two years.
So how did they get around? Like, I mean, can they move back in? What’s kind of the trick there?
Oh, well, if you’re talking about a separate rental property, then yes, if you have a, let’s say you live in one home and you have another one that is a rental property, and you’re facing a large capital gain, then what you want to do is move back into that other homes that was your rental property and live there for two years, and then you avoid the capital gains.
So let’s just say you you bought a house to live in actually, this was my case, for my first rental I bought back in 2009. I lived in there for a year. I rented it out for the next I think two or three years. But you’re saying if I would have just moved in for one more year, I would have been able to not have to pay the capital gain on the whole thing.
Right, you need to do live in it for another year for some stonework to have the last five, right now you still would be facing depreciation recapture. But you wouldn’t be facing capital gains.
Okay. So let’s talk about this other idea you and I were talking about so they have a larger home like maybe a million dollar property that they own. And you’re saying that they are renting it out for a year turning it into a quote unquote, commercial property, in that time costs, egging it out, pulling out the passive losses or the depreciation as and putting in their back pocket for passive losses. So when they do have a different real estate capital event, they can use that, but then they’re moving bright back into the property. unpack that for us how that’s possible.
Yeah, especially with the new rule laws that came out two and a half years ago. It allows for 100% immediate write off, technically, it’s depreciation, but you can take 100% of the value of everything we segregate and write it off in the first year. And then as long as you Don’t dispose of the property. So let’s say you rent it out for a year, and then you’re and then after that you move into it. You don’t have to recapture the depreciation until you sell. And let’s say you don’t sell it for 20 to 20 years. So you’ll have depreciation recapture in 20 years. And that assumes anyone even remembers what happened 20 years ago, but technically, that would be the way it would be recaptured. And certainly, it’s nice to get the deduction Now, while you’re in a high tax bracket, sell it 20 years down the road, when you may not be in the same high tax bracket. And on top of that, you have the time value of money of 20 years.
And for a lot of people that might be building their retirement home, right, they’re gonna plan to be in there for the rest of their life. But that’s kind of an ideal scenario.
Right. So then you never end up recapturing that depreciation. Yeah,
I’ve heard of like the I’ve gotten some legal advice, which I think is a little too aggressive, where they say, well, you just need to have the intention to rent it out or turn it into a commercial property. But you’re being a little more conservative here, you’re kind of guidances rented out for an entire year. Yeah. What’s your thoughts on that?
Well, most leases are going to be for a year. So typically, you rent it out, it’s going to be for a year, and then at that time you decide I think I want to live in it. And I don’t see how the IRS can really argue against it. Unless it was very, very obvious prior to you buying it or prior to you renting it out that that was your intention. And even then I don’t know if it matters, the fact of the matter is you did turn it into a rental by actually renting it out. Now, if you rent it out for only a week, then I would say no, but if you rent it for a whole year, I don’t see how they can argue against it. Right. And
a lot of this stuff isn’t tax evasion, right? I mean, you’re following the letter of the tax code.
So kind of going back to some people have a lot of single family homes like turnkey rentals, they typically cost $100,000. Yes. How much does it cost segregation cost? And does it make sense to do it on a smaller property? Is there a certain rule of thumb that you have on
in general, it’s hard to say that there’s an exact rule of thumb, but I have done studies on single family dwellings that were purchased for under $100,000. And actually, they work and one of the reasons is because we’re able to do those studies, generally for under $2,000. And the benefit that will be realized from a cost segregation study will exceed the cost of doing it by enough of a margin to make it worthwhile.
And that’s in a situation where the owner is looking to own that property for the longer time horizon 510 years plus,
yeah, that’s true. If you’re planning on disposing of the property a year or two later, it’s probably not worth doing the study on
on a couple of our Mississippi assets. We’re not super bullish on the market, we elected not to do the cost segregation, because I mean, the way that the projects are going, they’re going well, so we’re trying to unload them in the first few years. And yeah, our attorney or tax attorney kind of advises the general rule of thumb from there and is if you’re, if you’re looking to hold on to the property for more than three years, it makes sense to do it, but it’s less, it probably doesn’t make sense. But of course, that’s on a larger hundred 20 unit apartment or the cost segregation study might be $5,000. You know, that’s peanuts compared to the hundred thousand dollar this case? And we’re talking about, right? Yeah, that’s true, I would say three or four year time horizon. Sounds about right. And also what you want to take take into account is your expected tax bracket. So if you’re in a high tax bracket this year, but you think you’re not going to be in high tax bracket, even next year or the year after, then it may be worth doing because you get deductions in the higher tax year, tax bracket year and then you’re recapturing the depreciation in a lower tax bracket here. So in a way, it’s a little bit of a form of arbitrage. Right right. So let me kind of break this down for folks an idea that I had recently. Yeah, I guess maybe one day I’ll own my own house. I’m not a big fan of owning houses here in Hawaii or California especially where the rent to value ratios are nothing good. Right. Maybe one day all this investing will pan out and I can actually buy my wife a house instead of just renting. But if I were to buy a you know $3 million house which isn’t is probably the equivalent of somebody. A million dollar house in Alabama here in Hawaii. Just use a round number $3 million. Sharon Hawaii, I mean, I think that the land values are our majority of the price. So right, I would say one third of the $3 million is actual the building value, which you could depreciate two thirds of it being land. So that means a million dollars is possible to depreciate and going by the general rule of one third of the building value is depreciable. In the first year, with a cost, say, if I brought you out to Hawaii, which I’m sure you would like, and I don’t spend too much time here, and I’m not doing a study, you have to you have to tell me that you can’t tell me that. But um, yeah, pay, pay a few thousand bucks, do a cost segregation study, and then get a third of that million dollars. So $300,000 of passive losses in my pocket to use whenever I want.
So it’s always whenever you want, it’s wherever you can go, that’s the thing about passive losses is you have to be able to use them. Otherwise, sometimes, you can get caught in a situation where they’ll be suspended and carry forward until you can use them. Now, speaking of Hawaii, real estate, one thing that I have noticed, because I’ve done studies in two islands there, and that is the big island real estate tends to be less expensive than the other islands. So that can be something to consider. Yeah, well,
I don’t want to live there.
There’s nothing it’s a very rural area, right?
Well, no, Kailua Kona is, is barely happening. And I did a study of a five bedroom Airbnb that also had two other residential rental units attached to it, they only paid I think $700,000 for the property, and it was only maybe a 10 minute drive from downtown Chicago.
Yeah, out there, I would, you know, just kind of shooting numbers out there, I would say it probably be half half the price of the land to the building value. I kind of did a lot of research about this back in the day when I was a city engineer where we had to make offers to property owners to buy little slivers of land. And it just seemed like if you’re in a high priced area, the general rule is one third of the property is the land or the building value two thirds is the land value. And then when I look at my, my rentals in Georgia or Alabama, it’s the opposite.
Maybe actually, even less, what’s common here in the mainland, with the exception of maybe areas that are high price, like New York City or San Francisco, is that most accountants will will assign a value of about 20% of two of the purchase price to land. And that even includes where I am here, and it never seems to get challenged. So that’s why even where you are, I would imagine if you talk to your accountant, if you bought a $3 million house, they might assign 40% to the land value, even though in reality, it may be more of like two thirds, like you were saying
any last kind of tax tricks you kind of seen lately, that’s been maybe not talked as much.
Well, one thing is if you’re if you’re looking at all into commercial property, one thing that that came about within the recent passage of the cares act back in March, is that if you have a commercial property, or let’s say you buy one, and then you renovate it, the renovation of an existing building now qualifies as instead of 39 year property, which is for commercial property, it now qualifies as 15 year property and is eligible for the bonus depreciation, which allows you to write off 100% of your tenant improvement in the first year with the exception of certain things that would be considered structural, which would essentially amount to the four walls around the building the concrete floor and the roof. Any stairwells, elevators and escalators or anything that’s load bearing. Otherwise 100% of the tenant improvement will qualify as it can be completely written off in the first year.
Awesome. David, you want to get your contact information out there. We will also put it in the show notes. We’ll put this on simple passive cash flow calm slash cost sag. For you guys pull this video and want to
do my phone number here at the office is 480-963-2872. And we have done studies in 39 states. So we’re at some point we’re hoping to get the other 11 But anyway, one thing I’d like to add if I can is to kind of go into what exactly we are doing what what cost segregation entails. And what it entails is the identification and segregation of the value of various assets that are contained in the building as well as outside of the building that qualify for accelerated depreciation. And in a nutshell, everything outside qualifies because everything outside is considered a land improvement. So we’re talking concrete sidewalks, driveways, porches, patios, curving asphalt, landscaping, fencing, all that stuff qualifies for cost segregation. For accelerated depreciation inside, most flooring will qualify such as carpeting, vinyl, tile, vinyl sheet vinyl, laminate flooring, what will not qualify is wood flooring, or ceramic tile or any other kind of hard, titled, kitchen cabinetry will qualify the power to the appliances in the follow fi the the appliances themselves, the baseboards, and just ceiling fans, the whole host of things qualified to be accelerated outside segregated and outs from cost of the building and then accelerated depreciation.
And the reason why bring guys like David on the show is he’s the actual guy doing the work. And this is all small businesses, right? We are kind of the anti institutional investing world where there’s just middlemen upon middlemen upon middlemen, most cost segregation firms is just a bunch of salesmen, affiliate marketers, or David’s actually got going on to it. And if he has like a project in Nashville, and he’s going to do my go to Huntsville, and do your rental property. He’ll bill accordingly. And he’ll he’ll split the travel costs. I’m sure he’d love the Hawaii to.
Yeah, yeah, I guess I’ve done one there. Big Island and one in Maui. And yeah, so it’s and yes, I don’t I don’t stay for an extra week in June before. Right. I’ll do that.
Right. So yeah, I mean, a lot of the simple passive casual brand is kind of going off of value and getting the highest quality. Again, a lot of tough things we talked about today had to do with taxes, and we’re not giving any tax or legal advice here if you guys need a CPA referral and shoot me an email Layne at simple passive cash flow.com and if you haven’t connected before, let’s get on the phone and connect man looking forward to talking with all the investors out there. Thanks David. Thank you very much. This website offers very general information concerning real estate for investment purposes every investor situation is unique always seek the services of licensed third party appraisers inspectors to verify the value and condition of any property you intend to purchase. Use the services of professional title and escrow companies and licensed tax investment and or legal adviser before relying on any information contained here in information is not guaranteed as an every investment there is risk. The content found here is just my opinion and things change and I reserve the right to change my mind. Above all else, do your own analysis and think for yourself because in the end, you’re the only person who is going to look out for your best interests.