Taxes. They’re a perpetual thorn in the backside of anyone – property investor or not – but they literally keep our world going. The inconvenience of taxes and the way they take a hit on your bank account is why you should put more time into taking a look at tax reduction strategies. Yonah Weiss is a Business Director and an absolute powerhouse at working with property owners’ tax savings. Drawing on his experience, Yonah shows Lisa Hylton (and you) some of the most effective strategies for softening the blow of taxes on you. Be smart about your taxes!
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Eliminating Taxes With The Real Estate Investor’s Best Friend – Cost Segregation With Yonah Weiss
I’m excited to have on my show, Yonah Weiss. Yonah is a powerhouse with property owner’s tax savings. As a Business Director at Madison SPECS, a national cost segregation leader, he has assisted clients in saving tens of millions of dollars on taxes through cost segregation. He has a background in teaching and a passion for real estate and helping others. Thank you so much, Yonah, for coming on the show.
It is my pleasure, Lisa. Thank you so much for having me.
For the last couple of series, I’ve been talking about all of the different ways people can play in real estate. This episode is going to be a little bit different in the sense that it’s not necessarily about all the different ways people can play in real estate. It seeks to dive a little bit deeper into when you’re playing in real estate, some of the tools that you can utilize to help you in the area of taxes. In this case, we’re going to be diving into cost segregation. Yonah, can you tell us a little bit about yourself as a background?
I grew up in Southern California. I grew up in LA in the valley but I’ve been out of there for many years. It’s been interesting. I spent about fifteen years as a teacher, studying and teaching all grades in various topics. My passion is for teaching more than anything else. Several years ago, I got excited about real estate and wanting to expand my horizons, start investing and get into some wealth creation and building. I am a father of six beautiful children so I have a big family and I want to look after them. I found real estate to be a great opportunity. I want to learn everything there was. I started as a commercial mortgage broker, learning the whole aspect of commercial real estate from the lending side, the borrowing, and all the ins and outs.
I got my real estate brokers license. I wanted to find properties and help maybe do some fix and flips. We ended up doing five fix and flips out in New Jersey in the single-family residential. That definitely was not for me. I kept looking and exploring different options. I love multifamily and I loved the community that’s out there in the multifamily world so I got involved in that. I got involved with this company, Madison Commercial Real Estate, in which we service the commercial real estate industry in many different ways. Cost segregation is one of those strategies. I picked it up and I loved it from the first day and started teaching people about it. I found it to be extremely beneficial for a lot of people who didn’t know anything about the subject and were missing out on a lot of tax advantages. I took it upon myself to go and spread the word, come on podcasts with people like you and share the knowledge.
I’m sure people are dying to know, what is a cost segregation to begin with?
First of all, let’s get over the crazy name. We’re named cost segregation. I don’t know why the IRS came up with that, but in a nutshell, it’s a way of accelerating depreciation on a property. Cost segregation is taking the cost or the entire value of the building and segregating those costs or breaking out those costs into different components and categories that depreciate at different rates.
Let’s define what depreciation is.
That’s cost segregation. We’ll take a step back to understand further how to get there because depreciation, even though it sounds like a negative thing like something going down in value, it’s interesting. Depreciation is a theoretical tax deduction because it’s based on the fact that property goes down in value as time goes on. The IRS allows you to write-off, as a tax write-off from your income tax, the entire value of a property over a span of 39 years for commercial or for residential including multifamily, 27.5 years. That’s called depreciation tax write-off. It doesn’t mean that things are going down in value because most likely your property is going up in value or appreciating as time goes on. It’s like a hypothetical theoretical tax deduction based on the concept that things go down in value.
The first thing to get over that hump is that depreciation is a good thing. It’s based on that concept of things going down in value. That being said, we’re taking a little bit of tax deduction each year for 27 or 39 years. That’s good because if you bought a $1 million building. Take off the land because land does not depreciate, but whatever you’re left with, let’s say $800,000 of that, you can take that as a tax write-off. That’s about $20,000 or $30,000 a year every single year for the next 27 or 39 years. Cost segregation is a way to check out that property and find things that depreciate on a 5 or 15-year scale, which allows you to take those deductions or those tax write-off much faster. Bigger tax deductions earlier on in the ownership and that creates greater cashflow, that’s what cost segregation is.
What is the process of executing a cost segregation study?
The first step is IRS requires a whole rule system. It’s called the Cost Segregation Audit Techniques Guide. Everyone can check that out. It’s a great read on the IRS website, especially if you love reading tax literature. There is a whole list of requirements that go into cost segregation study. One of the things they require is that a qualified engineer needs to come to the property, analyze the property, come and take notes and pictures, do a whole analysis and create a report. Even before we do that, we offer an upfront analysis at no cost and no obligation to show you what the potential tax savings are on your property even before we go ahead and do that.
The process entails simply that. If you see those numbers make sense, you engage a firm like Madison SPECS or another firm that’s comfortable doing this and send an engineer to the property. They come to create a report which creates an updated depreciation schedule. Instead of your straight-line depreciation schedule, which would have been the building over 27 years a little bit, it’s going to break it down to 5, 7, 10, 15 or 27 years. Get all those categories of what those tax deductions are. The report itself is extremely detailed. We’re talking about 80, 90 or 100 pages long of detail of what are all the assets and what’s the value of each thing.
Some of those things could be like the roof would be allocated a portion of the cost. If you bought a building for $1 million, maybe they’ll say, “The land is just $200,000 of this $1 million.” The engineer is going to then do their work to say, “The roof is $100,000 and then the HVAC system is this amount.” They then apply the years.
There are tons of things in there. The first category, which is the biggest is called personal property or tangible property, which depreciates on a five-year schedule. That includes anything that’s in a building that’s not part of the structure. The structural component is going to depreciate on a 27.5 or 39 years schedule, but everything else can be re-allocated to a faster schedule. The biggest of which is that five-year personal property, which can include stuff that you wouldn’t even think of like carpeting, vinyl flooring and cabinets. In a residential multifamily property, you have stuff like countertops, kitchen, appliances, furniture, fixtures, all that stuff has a lot of value and many more. There are over a dozen other things that can go in there. Commercial properties are going to be no similar but different things like cable systems, telephone, intercom systems, all that stuff, even lighting and electrical. All those depreciate on a five-year schedule, which is a lot of value. We’re talking 20%, 30% up to 40% sometimes of the value of the property can be allocated to this five-year schedule.
What would the structural pieces be then?
It’s what’s the building. You have the floor, roof and walls. Structural can include stuff like the main plumbing and electrical system. All of that is considered structural and the value of those assets depreciate on that longer 27 or 39-year schedule. It’s usually going to be the majority of the value of the building itself are going to be in those components.
People are probably thinking, “If I buy an asset from someone else,” especially if you’re buying something to do value add work on it, “it’s not brand new, so do I have the ability to still get depreciation expense in this cost segregation? Does it still make sense for me?”
Going back to my original point that this whole depreciation thing is hypothetical because it doesn’t have to do with when the building was built. Because depreciation is a tax deduction for you, it starts over when you buy a building. You buy a building that was built in 1927. When you buy it now based on your purchase price, that’s the amount now starting your 27 or 39-year schedule. It starts when you can write-off that building. If you’re buying a new property, this is going to be one of the most relevant.
Who wants to even have a cost segregation study to be done? Is it a person buying a single-family?
The bigger the property is, the more benefit it’s going to be. Think about a percentage of the purchase price of allocating to faster depreciation and bigger tax deductions. There’s a fee involved in actual service. My rule of thumb is any property purchased for over $1 million is usually a no-brainer. At over $500,000, it usually makes sense as well but definitely worth checking out the numbers. Under that value, it usually doesn’t make sense. There may still be some tax benefit there but usually, it’s not going to be beneficial in terms of what those actual tax benefits are going to be. However, it doesn’t matter if it’s a single-family, multifamily, an office or retail. Mobile home parks are great for cost segregation. It’s worth checking out those numbers and seeing what’s going to make sense in that particular situation.
In the case of the people who are benefiting from the cost segregation study.
Anyone, as long as you are taxable. If you are a nonprofit, you’re not going to be paying taxes. It’s not going to benefit you. If you are an educational system, a school or something that’s government, it’s not taxable. It’s not going to be beneficial. Something that people also started doing lately a lot is investing from their retirement funds, which are not taxable like a 401(k) or a self-directed Roth IRA. Those funds are not taxable. Having depreciation deductions, creating tax deductions or something that’s not taxable does not benefit you. It’s always going to make sense in your situation when you are taxable. You need those extra deductions to help offset your income tax. The goal here is to lower your income tax to pay little to no income tax and to increase that cashflow.
Another item is the topic of bonus depreciation. Can you talk about what that is and how it differs from regular depreciation?
This was something that came about in the tax reform in the Tax Cuts and JOBS Act of 2017 to 2018, which was 100% bonus depreciation. According to tax rules, this allows that any property depreciates in less than twenty years. That is everything that we are allocating in cost segregation. My personal property has what’s called fifteen-year land improvements. The stuff that’s outside of the building like concrete pavement, parking lot, landscaping, fencing, signage. All that stuff depreciates on a fifteen-year schedule. All that stuff, you can choose as an option to take that in the first year, meaning all of those deductions take that all in year number one. That’s called 100% bonus depreciation. It’s not something different than cost segregation. It’s an option. Once you’ve done a cost segregation study, you can choose or you can elect to put all of that on a one-year schedule. Let’s say 20% to 30% of the depreciation of the value of the building and take a tax write-off in the first year. To give a picture of what that looks like, buy a building for $1 million. The land doesn’t depreciate and $800,000 is left. Take 25% of that as tax, that’s $200,000 as a first-year tax write-off. That’s incredible. It’s a game-changer for most people.
For instance, a syndicator decides to buy a multifamily building and you were talking about the concrete and that stuff. If they decide that a part of their business plan is to do some renovations on the outside of the building, the cost of that would then be depreciated fifteen years. Is that what you’re saying?Depreciation starts on day one of the purchase. Click To Tweet
First of all, there are two things that are happening. When you buy a building, you get to do depreciation on the value of what you bought. That includes everything in the purchase like land improvements and everything. You can do the cost segregation right away on the acquisition cost. That’s your purchase price, that’s going to be your basis for depreciation from day one. When you’re going to do some improvements, you’re going to put in a new parking lot or a swimming pool, you’re going to redo all the landscaping, all that stuff are land improvements. You can now do a second cost segregation study on the value of those capital improvements. That goes for the interiors also. If you’re gutting the kitchen and bathrooms, you’re putting in whole cabinets, not only can you now write-off the value of what you dispose of as a tax write-off, but you can now do a segregation report on what you put in. Any money that you spend on improving a property is added to your basis and needs to be depreciated. Are you going to put that all on a 27.5-year schedule? Do you want to accelerate that and have the option to take that bonus depreciation tax write-off in the first year for the money you spent?
The idea of being able to bring on firms like yourself that would then give you an analysis as to whether it will be worth it. It’s to pay the money to get the cost segregation done to be able to then have those benefits.
Years ago, only the biggest tax firms did this like the big four. They were the only ones who were doing cost segregation and it costs $50,000 or whatever to get a cost segregation study done. Nowadays, it costs a fraction of that. We’re talking like $4,000, $5,000 or $6,000 for a study depending on the size and the scope work of the property, not contingent on the tax savings. That’s where you’re going to see, “Is this going to be beneficial or is it not?”
I want to talk a little bit more about the investors who would be in a project of purchasing a building and the actual impact the cost segregation study has on them, especially ones that are real estate professionals versus non-real estate professionals. Can you talk about that a bit?
Let’s define what’s a real estate professional because this is not like a term is just thrown in. This is an IRS defined status. This status of a real estate professional allows you to use tax deductions created from depreciation to offset your income from any other source. This is cool. Usually, depreciation is considered a passive deduction which offsets passive income. Passive income is income produced from your properties if you income your properties. The main impact that’s happening on everyone is whatever income comes in from the property, the depreciation can be used to offset that, meaning lowering the tax liability. Let’s say you made $10,000 from your property and you had $10,000 from depreciation, you’re going to be taxed on zero so that income is essentially tax-free. That’s across the board.
A real estate professional, which is defined by the IRS, is someone who they or their spouse, either/or, has to meet one or both of the following two qualifications. Number one, they need to be spending more than 50% of their time materially participating in real estate activities. If you own properties and you’re managing them, you’re brokering, if you’re doing construction or doing anything that’s involved in the actual running of real estate, it needs to be 750 hours a year, which is not a lot. It’s a requirement so that you can’t just sit on the beach all day and not do any work and still get that status.
Once you have those qualifications, you are considered a real estate professional. Now, you can use deductions from depreciation to offset all of your income from any source. Even if you have a W-2 and your spouse has a W-2 income, you can do cost segregation and get that bonus depreciation. For example, $200,000 of deductions and you’re $10,000 in profit from your property, that extra $190,000 of deduction does not go to waste. It can now spill over to your regular income or your ordinary income and offset that to pay no tax on that as well.
If you are not a real estate professional, that extra $190,000, what happens to that? You can’t take it because you can’t offset it all.
It doesn’t go away or disappear. It creates a passive loss and that carries forward. That means you get to use that in future years. It goes into this imaginary bank account on your tax return. It’s a minus. You have a negative $190,000 and then that carries forward to next year. If you need those benefits, that carry forward and you can then use them next year that stays with you until you sell the property. Once you sell that property, those losses are released and then you can either use them that year or at that point they’re lost.
When we go to sell the property, is there a depreciation recapture and if so, how does that work?
When you sell any property, you have a depreciation recapture tax. Besides the regular capital gains tax, when you sell a property, if you sell for profit, you have to pay capital gains tax. There’s also something called depreciation recapture tax, which means that you are taxed at a 25% tax rate on the depreciation that was taken during the life of ownership. Whether you do cost segregation or not and whether you even take depreciation or not. It’s a crazy thing that let’s say someone forgot to claim depreciation when they decided that they don’t need that and they don’t want it. The IRS considers it as if you took it. You have to pay the tax whether or not you even took it, which is crazy.
It’s in your benefit to take it because you’re going to end up having to pay this at the end.
It’s like I say, “I’m going to lend you $100,” and you’re like, “I don’t want to borrow it,” but you have to pay me back anyways.
What are some of the options investors have to avoid paying, pushing off or delaying paying that depreciation recapture tax?
The first and foremost, the most common thing is something called a 1031 exchange. It’s another great tax strategy that you can sell a property by doing an exchange. Meaning exchanging it for a like kind property and anything else that’s real estate. By doing that, you not only defer your capital gains tax which is the main strategy if you will do it but you also defer that depreciation recapture tax to a later date. You can keep doing this. You can sell property A, buy property B, and hold that for ten years then exchange that for another one for ten years. Keep doing that until, as we say swap until you drop.
When you do drop, what happens?
What happens is that usually it’s done right and this takes a little tax planning but if done right, that property is given as an inheritance if you have inheritors. They inherit that and not only did they not have to pay the capital gains because it’s no longer yours. It’s no longer the original persons. They get that tax-free. Not only did the inheritors get that tax-free, but they get a step up in basis, which means they get to look at that property and they own it. They’re going to have to pay some inheritance tax, but they get that as a look at the fair market value of what the property is worth when you inherited it. That’s their new basis. They get to start depreciation over from day one based on a fair market value of that property. Let’s say you own a property for 50 years and you bought it for $10,000. The person dies and leaves it to their son and the fair market value is $5 million. They get to start over depreciation for $5 million as a tax write-off.
They will have the inheritance tax to deal with potentially.
Yes, but they won’t have any depreciation recapture, capital gains tax or anything like that.
I’m curious about ideal assets or what type of properties lend themselves well for cost segregation studies?
All types of properties do but there are some that are more beneficial than others. For example, I’m interested in golf courses and mobile home parks because of the new tax law bonus depreciation. Those are two of the most advantageous types of properties out there for someone looking for major tax deductions because they’re almost entirely land improvements. Not just land, but landscaping and mobile home parks are like pavements. You don’t own the homes themselves. You just own the park and the tenants own their homes. You own the parks and those concrete pads and the landscaping.
I’ve seen 60%, 70% to 80% of the value of that property is allocated to land improvements, which with the 100% bonus depreciation. That’s a first-year tax write-off. Those are crazy awesome deductions. It’s like an RV park that had an 87% land improvement allocation, which was crazy. Other types of assets like office buildings, especially medical office buildings, nursing homes or assisted living facilities have a lot because the personal property, the beds, all the equipment and all that stuff that’s in there are high value. Any apartments are also good like multifamily. We’re talking 25% to 35% reallocation. It’s usually faster depreciation. There’s a lot of good stuff.
Are there any drawbacks to cost segregation studies?
The biggest drawback would be if you don’t need it. There’s no reason in creating extra deductions if you can’t use them. The second biggest drawback might be tax planning and depreciation recapture. If you’re not planning on holding the property for more than two years, it may not be your best interest to get the cost segregation done, if you’re just going to have to deal with depreciation recapture. After three years, it’s already usually advantageous because of partial asset disposition which allows you to claim a lesser value to that five-year property and therefore not even pay depreciation recapture on that.
It’s such good stuff. I appreciate you coming on. I usually ask all my guests a couple of questions. They’re called level-up questions. The first one is, what are you grateful for in your life at the moment?
I’m grateful for my children and my wife. Family is the biggest thing. I’m grateful for all of them. They teach me many lessons every day.Everything comes from a higher source of power. The people around you are helping you, doing things for you, even if you don't recognize it. Click To Tweet
What are the top three lessons you learn in your journey so far real estate, non-real estate, etc.?
Number one, be humble. I’ve always known this, but it’s something that you keep learning and keep understanding because as soon as you start that little bit of arrogance like, “I did this on my own,” and I can’t stand people who are like, “I’m a self-made millionaire.” There’s no such thing. Everything is teamwork. Everything comes from a higher source. A lot of it comes from other people that you don’t even recognize that they’re helping you and doing things for you. Of course, from a higher power. Number two, which is related to that, is to be a team player.
Being a team player can mean a lot of things to a lot of different people but for me, it means going out of your way to do things for other people in your office or in your company even though they don’t ask. That’s going to get you much further than you even imagined and it comes back to so much more. The third thing is the incredible, amazing power of LinkedIn. I have seen a 5,000% growth rate in my business from LinkedIn in 2019. It means there is incredible potential and incredible network out there. It just needs to be understood, learned and utilized in the correct way. It can be a game-changer for a lot of people in the business.
What do you believe is key to your continuous success and growth?
It’s all those things I just mentioned. To add to that, giving ten times more than you would ever expect to receive. Believe it or not, people think, “I’m not growing that way,” but you’re growing tremendously not only as a person spiritually but because people who you give to will come and give back even more. It’s definitely a great strategy.
What advice do you have for people just getting started in real estate, given your varied experiences in the real estate industry?
Keep learning. There’s so much to learn. You can spend ten years learning and still not even scratch the surface. The second thing, which I would couple with that is do. Find people who you can align yourself with and you can learn from on the ground. Meaning, get out there and do something. Don’t just sit back, read books and listen to podcasts. Go out and do something. Go out and take some action. Meet people, apprentice and learn from people who are doing it already.
What do you wish you had known at the beginning of your journey that you now know?
I wish I knew how powerful investing is in real estate at the beginning because it took me about five years to understand how powerful it is. Had I invested money five years ago, that probably would have doubled already. You’ve got to start somewhere so I’m glad I know now.
Thank you so much, Yonah, for coming on. I appreciate it.
It’s my pleasure, Lisa. Thank you again for having me.
That was another amazing episode. I enjoyed talking with Yonah about cost segregation studies, real estate professional rules and all that good stuff. It was definitely a show that had lots of good information about technical stuff regarding real estate. Some of my insights was the fact that cost segregation studies, while they can be beneficial, you want to keep in mind that if you are unable to take all of the depreciation. For instance, if you’re not a real estate professional, then you won’t necessarily be able to take those depreciation losses and paper losses against your W-2 income. Unless you’re married and your partner is a real estate professional or you are a real estate professional, then you can offset the losses across your other income.
I thought that was interesting to know. That said, those losses do carry forward so then you will have a bank of them. As you have a passive income in future years, you can then use those passive losses to counteract that income so that ultimately, you don’t end up having to pay it. I also thought it was fascinating with the depreciation recapture tax. The fact that regardless of whether you choose to take the depreciation expense during the hold of your property and whether you take that or not, in the end when you sell your property, the IRS is going to assess depreciation recapture tax. It is in your best interest to take whatever depreciation expense you can that is offered to you under the IRS rules and regulations. Because why not? You’re leaving money on the table. It makes sense.
I love all the different types of options like the 1031 exchange. It does require tax planning and it does require you to be intentional about selling, finding another property to roll the money in and following the IRS rules. If you want to benefit from these rules, it’s a price that you’re paying, which is being able to take the time to put the plans in place to make sure that it works out according to what the IRS wants. It’s definitely a great episode with a lot of good information. I also thought it was fascinating the different types of properties that experienced such high depreciation. Being able to write-off so much of the cost of the property, which was golf courses, mobile home parks, and RV parks. It’s definitely a lot of good stuff to think about. If you’re out there, you’re investing in real estate and some of these are the things that you’re thinking about investing, I hope that this brought some good information for you as well. Until next time. Keep leveling up. Take care.
- Yonah Weiss
- Madison SPECS
- Cost Segregation Audit Techniques Guide
About Yonah Weiss
Yonah is a powerhouse with property owners’ tax savings. As Business Director at Madison SPECS, a national Cost Segregation leader, he has assisted clients in saving tens of millions of dollars on taxes through cost segregation.
He has a background in teaching and a passion for real estate and helping others.