Yonah Weiss is a business director with Madison Specs, a national cost segregation leader helping clients save tens of millions of dollars on taxes.
Cost Segregation is an IRS approved process for reclassifying real estate components and improvements to accelerate depreciation deductions, defer taxes, and improve cash flow. Yonah and Mark discuss various strategies in this week’s episode, showing investors how to reap all the benefits from owning investment real estate.
What You’ll Learn In Today’s Episode:
- The government incentivizes real estate investors. By taking advantage of these incentives, such as cost segregation, bonus depreciation, or real estate professional status, you can completely nullify your tax burden, increasing your cash flow and allowing you to buy more real estate. It is vital to have key team members, such as a cost segregation specialist like Yonah, and a real estate focused CPA, to fully understand and take advantage of these situations..
- The cost of having a cost segregation study completed has dropped dramatically over the years. If you own any type of investment or business property, it is worth speaking with a cost segregation specialist and your CPA to see if this strategy is right for you.
- One factor with owning investment real estate, and specifically when using strategies like cost segregation, is to consider how you will be handling the sale of the property. Cost segregation is great for accelerating your depreciation and increasing your retained earnings over the typical hold time for a property, but at the sale that depreciation must be recaptured. There are a few strategies to avoid this, the most common being the 1031 strategy. We strongly recommend you discuss this with your CPA to fully assess your individual situation.
Ideas Worth Sharing:
“You literally can make money, and the government is giving you these incentives, using tax strategies, to keep the money you make.” – Yonah Weiss
“Cost segregation and depreciation in general is applied to any type of investment or business property.” – Yonah Weiss
“$500,000 and up is where it really starts making sense to do it [cost segregation study].” – Yonah Weiss
Resources In Today’s Episode:
Books Mentioned In Today’s Podcast
- As Long As I Live by Aharon Margalit
Enjoy the show? Use the Links Below to Subscribe:
Mark: Today’s guest is a business director with Madison SPECS, a national cost segregation leader, helping clients save tens of millions of dollars in taxes. He’s also a multifamily investor and the host of Weiss Advice Podcast. I’d like to welcome Yonah Weiss.
Yonah: Hello, Mark. Thanks for the introduction. How are you doing today?
Mark: I’m great. How are you?
Yonah: Wonderful. Absolutely.
Mark: Yes. So, you were on separate coasts. You’re in, the New York, greater New York area, New Jersey.
Yonah: That’s right.
Mark: I’m out here in LA and I’m excited to hear your story and to learn about your tax specialty.
Mark: Which is cost segregation.
Yonah: Let’s do it. Let’s jump right in.
Mark: How long have you been in cost segregation? Are you a CPA?
Yonah: I’m not a CPA. I work for the largest cost segregation company in the country. So, I’ve only been in this space for about three years and I’m really more on the business development side of the business.
Yonah: I don’t need to be a CPA because I don’t actually do any of the real work that goes into it, which I just go around teaching about it. And I’ve learned from the experts in the field and really my background is in teaching and education. So, it gives me a nice advantage to be able to, use that skill and then take the business and sometime a very complicated topic and boil it down to be very simplified so anyone can understand.
Mark: Will alright. I’m excited to try to do just that is try to simplify this somewhat confusing thing. I love cost segregation. I do it first thing after closing on a new property and just to get that going, do you want to give us an overview of cost segregation?
Yonah: It’s a really weird name, but to clear up what it is, you really have to understand what depreciation is because all cost segregation is it’s really an advanced form of depreciation, which is probably one of the best tax deductions that you get when you own a piece of property, especially if it’s commercial real estate. It does not apply to your personal residence, but if you buy any investment property whatsoever, the IRS allows you to literally write off as a tax, write off for your income tax, the entire value of that property.
That’s called depreciation. However, you have to do it over a long period of time. So, it’s for commercial properties over 39-year period, residential, including multifamily over 27 1/2-year periods So you basically take that purchase price, whatever was paid, subtract a little bit for land. Land itself, doesn’t depreciate, but whatever’s leftover. Now. You can literally take that as a tax, write off a little bit every year for 27 years.
Mark: For my own clarification.
Mark: Give some context to this because I was thinking about it just before we started recording. So, you just mentioned, you pay property taxes every year and the County assumes that the value of your property is increasing every year and it’s divided between land and improvements or the structure. And so, they’re assuming that your property value is going up.
However, it’s probably mostly the land in the location that are increasing in value and the building or the structures are made up of roofs, walls, foundations, refrigerators, stoves, AC units, and that stuff is at peak value the day you buy it. You don’t buy a fridge and hoping that it’s going to increase in value. There’s no refrigerator, stock exchange where people trade those things. ‘Cause they just go down in value from day one and all those components go down in value at different rates. Is that accurate? Does that sound accurate?
Yonah: Exactly. So that’s really what cost segregation is, but what really ends up happening is even though the IRS is giving it that value, but in truth, it actually is going up in value. Meaning the land for sure is going up in value, like you said, but real estate in general, you may buy a property today for a million dollars and five years from now that property, including all the improvements that are on it, including the building, including those appliances and everything in there has now gone up to $5 million.
So, it’s really everything, all-inclusive is what’s going up in value, even though intrinsically those things, those improvements, the walls and doors should be going down in value. So, there’s a big clarification when we’re talking about depreciation and that’s the concept exactly what you hit the nail on the head.
The concept of depreciation is that things go down in value as time goes on and have a useful life. And therefore, you have to replace them every certain number of years. You have to put in a new carpet every five years or 10 years. However, the IRS looks at it really from it’s a borrowed term because the day that depreciation schedule starts is the day that you purchased the building. Okay.
Yonah: Which is completely mind boggling, according to what you just laid out for us, because really this stuff should go down in value. And therefore, when I buy it five years from now, it should have a lesser value and I should only be able to continue the depreciation schedule that started when that building was built. Okay.
Yonah: That’s not so.
Mark: Is it fair to say that the land and the location are out-performing and over-performing in value increase and making up for the depreciation in the structure? For example, if you buy a building that’s 40 years old, that building, if you just replace that building with the exact same structure built in 2020, the 2020 property would be more valued.
Mark: On a purely structural basis.
Yonah: That is accurate. Correct.
Mark: Maybe I’m getting into the weeds on this one.
Yonah: You are a little bit, but it’s important to understand because that actually does come into play when we’re discussing cost segregation depreciation. So, it’s not entirely hypothetical because there is a small percentage where we’ll look at the real useful life of the building versus the practical, useful life, which is, placed in service. And that schedule that 27-year schedule starts from the day that you purchased it. So, there is that kind of calculation and the percentages are minuscule, but it still does come into effect.
Mark: And most owners don’t end up replacing everything, every aspect of the building in 27 years.
Yonah: No. However, from a real financial look at the building, when you get an appraisal, the appraiser does the exact same thing that a cost segregation engineer will do. However, they’re looking at the real value. They’re going to say that roof has a ten-year, 15-year useful life, it needs to be replaced in three years. So therefore, the value of that roof is going to be appraised less.
Mark: Got it.
Yonah: And therefore, you’re going to get a lower appraisal altogether. However, the IRS puts that into the tax code and says, yeah, all these things have different useful lives, but they start over from day one when you buy the property. So, the engineer’s going to look at the same exact things may get to the same useful lives, but then they’ll apply the tax code and say, well, the tax code says that the appliances, the furniture, all that stuff in the building, that’s new. Now part of the structure depreciates on a five-year schedule and it starts over day one when you buy it.
Mark: That’s a great distinction. I hadn’t thought of that. They’re not really accurately coming in and examining each component of your property there. You’re just buying it. And they’re giving you a set schedule of depreciation for each part of it.
Yonah: No. So, the cost segregation, what we do is we actually go in and look at the building engineer will go in and part of the process of cost segregation let’s just lay it out a little more clear because I said, it’s like an advanced form of depreciation. The IRS has laid out, every type of asset possible and every category of types of asset possible, whether it’s appliances or furnishings or, landscaping, all these things are put on a certain schedule. Okay. And the value of those assets depreciate on that schedule.
So, the process of getting cost segregation study done, entails an engineer coming to the property and actually examining everything, identifying what all of those assets are. How many cabinets are there in this multifamily building? How much square footage of carpeting or vinyl flooring there is. How much square footage of the parking lot, the asphalt and all of those individual things have different value to them and apply the square footage is going to come up with the cost. Okay.
So, there’s the name of cost segregation. And we’re going to segregate out all those different assets into the different categories and take those depreciation deductions faster at the owner’s faster life. So that’s really the crux of the whole thing. We’re taking faster depreciation deductions by identifying what those things are within the building that we can now depreciate or take those tax deductions faster.
Mark: So, if you don’t do that, you’re stuck with a much more generic, one size fits all depreciation and it’s just zeroing in drilling down and breaking everything out into separate parts.
Yonah: Exactly. And what that does is that creates larger tax deduction. Okay. So, we’re deducting more money from our income tax, which potentially, and many times with cost segregation, it literally nullifies your tax liability in many cases. So, you will actually have more deductions than you have income. And what that does, it increases your cash flow. Because you made a hundred thousand dollars from the net operating income of the property and you have no tax on that money.
Guess what? That a hundred thousand stays in your pocket. And this is really a paradigm shift for a lot of people because especially if we’re working in corporate America and we’re working a W2 job this income tax is deducted from our pay check. We never see it. We never see that money. How much in real estate can says, you own a property.
You get the income; you have all these expenses at the end of the day. At the end of the year, you have to now go and add up all those expenses including depreciation, which is just a kind of a phantom expense. It’s an imaginary expense.
Yonah: And now you deduct that whatever’s left over, from all those expenses, including depreciation, that amount is what you’re taxed on. And you have to, go submit a tax form, but you can literally have more deductions than you have income. And all of that income stays with you.
Mark: One of the big advantages of real estate investing is the tax, the favorable tax treatment. And it goes back to that Robert Kiyosaki quote. I think it’s, “It’s not what you make. It’s what you keep.”
Yonah: It’s something that most people don’t understand. That’s why I like to call it a paradigm shift because you literally can make money. And the government is giving you these incentives of these tax strategies and things that you should be applying in order to make sure you’re getting those tax deductions and keeping the money that you make. As simple as that.
Mark: And the tax code seems to be changing little by little and wasn’t at the overhaul in 2017, ’18, they improved it a little bit on the cost SEG front.
Yonah: Yes. They, made actually a huge improvement in the tax cuts and jobs act. The Trump, tax reform was probably the biggest tax reform in decades. And one of the big things that happened there was they introduced a law called 100% bonus depreciation. And what that law says is that if you get a cost segregation study done, okay, and you can identify all of the property that depreciates at a faster schedule.
All the five-year property, that’s the personal property, all the land improvements, that’s on a 15-year schedule. You can now, instead of just taking, more deductions over a faster period, you can literally choose.
It’s an option to take all of that accelerated depreciation in year number one in the first year as a 100% tax deduction. So simple example, I like to give, just to understand how this works is, let’s say you bought a building for a million dollars and you got 20% of that, forget the land value for a minute, just to understand the property.
This example, 20% is allocated to five-year property, which is that personal property. It’s pretty typical for multifamily properties if you earn around that amount, $200,000. That means you’ve created a $200,000 of front-loading those depreciation deductions and taking them in the first five years. So, you can either take them in the first five years and get an extra $40,000 a year. On top of your regular depreciation, which would be probably somewhere $30,000 a year, or you could opt to take the entire $200,000 as an income tax deduction in year one. So, it’s huge.
Mark: That’s amazing. And you mentioned that it doesn’t apply to your personal residence, but you want to speak to what it applies to and what it doesn’t apply to.
Yonah: Yes. Cost segregation and depreciation in general is applied to any type of investment or business property. So, business property, something that a lot of people don’t think about, you may have someone who’s a doctor that owns the building, the office clinic, where they work out of. They don’t think of themselves as a real estate investor, but the building they own, or the building, their business owns more accurately, often is eligible for depreciation and can have a cost segregation study done on it.
So too, with any type of business that owns a property or any investor, if you own single families, if you own multifamily, retail, office, industrial, self-storage, golf courses, you name it, mobile home parks, anything where you own real estate and you are an investor, it’s not your personal residence. You actually get depreciation and you can utilize cost segregation.
But really only starts making sense. In my opinion, kind of my rule of thumb is anything over half a million-dollar purchase price. So, $500,000 and up is really where it’s going to really start making a lot of sense to do it because it’s a percentage of tax deduction. Again, like finding a certain percentage and taking those deductions earlier.
Mark: And in the cost of doing a cost SEG is probably what makes it make less sense on smaller building values. Is that accurate?
Yonah: Exactly. It’s going to cost, somewhere minimally, a few thousand dollars, anywhere upwards of potentially $10,000, depending on the size and shape and whatnot of the property. So yeah, it’s going to obviously going to be a factor in the deciding factor where it’s going to start making sense, I’m going to make this investment and then, am I going to get the returns on that investment?
Mark: Now, if you’re enjoying the show, please do us an easy favor and hit the subscribe button. As a listener I always wondered why podcast hosts are always begging me to subscribe and rate them. Well, now that I’m on the other side, I see why. It allows other listeners to find you. In an era of unprecedented hype over real estate investing. My goal is to be a truth teller. Real estate is not as easy as it’s made out to be, but you can do it if you can get past the hype and get to the truth.
My aim is for this show to help with that. And if you’d like to learn more about who we are and what we do at Quantum Capital, please visit our website at quantumcapitalinc.com, where you can find podcast episodes, multifamily resources, and learn about opportunities to invest with us. Anyway, let’s get back to the show
Mark: Cost segregation for a long time. And I saw it gets super charged after the tax reform act. So, it’s really beneficial right now. There is a catch to it. However, and do you want to speak to that? And it’s the depreciation recapture and maybe explain how that works as well. And maybe a factor that you should consider.
Yonah: A hundred percent.
Mark: As part of it.
Yonah: As all tax deductions and all tax benefits. First of all, just disclaimer, we started this, I’m not a CPA. And I’m definitely not your CPA if you’re listening to this. So, you want to be able to discuss this and any tax benefit. You want to make sure that it fits with your strategy and your overall business plan, your overall tax structure. So, the first thing you have to know about depreciation is that when you sell a building, when you sell that property, you have not only capital gains tax, which is a tax you have to pay on the gain.
If you made any profit on the sale of that property, you now have to pay capital gains tax. You also have something called depreciation recapture tax, which means you have to pay a tax on the amount of depreciation that you took over the course of ownership of the property. There are many strategies to get around paying that depreciation recapture tax.
So, it’s not like just in a box you do this and then you do that. You buy a property, you take depreciation, you sell property, you pay tax on it. There are other strategies that you can actually get around that as well, or defer that, or even eliminate that. So, it is important to understand that it does exist and put it in your business plan that it’s going to come up or may come up and make sure that it still makes sense to do the cost segregation.
Mark: What about, a very common go to when people are selling a building if they want a 1031 exchange and it defers capital gains. How does depreciation recapture get treated in a 1031 exchange?
Yonah: So, 1031 exchange is the perfect example because that not only defers the capital gains tax, like you said, it also defers the depreciation recapture tax. So, a great strategy when selling your building to get around a lot of these taxes is to do a 1031 exchange. Which if you don’t know what that is very simply just a way to sell your building without, jumping through a few hoops, by filling out certain forms and doing things within parameters that tax code allows you to exchange the property for another building. Instead of selling property ‘A’ buying property ‘B’ you exchange property ‘A’ for property ‘B’, and therefore you can defer taxes.
Mark: It fits within the parameters. If you sell your building, the proceeds go to a 1031 exchange accommodator you have 45 days to identify the building that the property that you’re going to buy with those proceeds. And then you have to close within six months or 180 days. Is that accurate?
Yonah: More or less?
Mark: Well, that’s a good overview of a cost SEG. Are there other strategies that I’m not recognizing at sale other than a 1031 exchange?
Yonah: Sure. There are a couple and again, I’m not a CPA, but I work with them hand in hand and I probably know more about this subject than most CPAs do. That being said, there’s something called partial asset disposition, which is something very common as well, common strategy that most CPA’s probably should know about and are doing, but some may not.
And what that entails are, we’ve identified by doing a cost segregation study, all of the personal property that it really has a five-year life, okay. Have five-year tax life, useful life. After five years from a tax perspective, there’s literally no more value or no more book value to those assets. So, you can get a cost segregation study done.
And then when you sell the property, do this partial asset disposition, which means you file a form. It’s not just something that is inherent and gets done right away. You actually have to file a form upon sale that says these assets, they identified have no more value to them. No more value means you no longer pay or have to pay little to no depreciation recapture tax on those assets because you’ve basically disposed of them and they have no more value to them.
So that’s one thing. And you can do that as well in the course of ownership, if you were to do renovations and let’s say, get rid of all your appliances, you can also do partial asset engineer and just write that off of your depreciation schedule. So as a tax, write off, if any value that’s left on those things as well. So that’s one way to go about doing it.
Another strategy, a lot of people don’t know about another great thing to know is that if you’re a real estate professional, and this is something you probably should have prefaced with a little bit earlier because cost segregation is going to be beneficial for you. Really mostly only if you’re a real estate professional. It’s going to be more beneficial to you if you are a real estate professional.
And the reason for that is there’s a special tax treatment for real estate professional. If you qualify. And again, some more hoops to jump through some more boxes to check, they have to qualify for this tax nomenclature if you will. As a real estate professional, you have to spend, basically full time in real estate, you have to have 50% of your time spent in that.
You can’t really have another full-time job either you or your spouse can qualify and you can get that qualification and then 750 hours. But in short, what that allows you to do is to use depreciation to offset any of your income. So active income, non-passive income as well. Normally depreciation deductions would only be able to use against your passive income.
Meaning income from your properties comes real estate professional status it says, create more deductions. Cost segregation, let’s get bonus depreciation. Let’s get as many deductions as we can. And I’m not limited to how much of those deductions I can use this year to offset any of my annual income.
Mark: So typically, most people don’t have mammoth passive income and cost segregation basically creates massive passive depreciation, which in theory should best offset, massive passive income. But when you become a real estate professional, suddenly the rules adjust and you are allowed to take all of that depreciation against your income.
Yonah: Yes. Your active income and any income for that matter. So that’s probably a huge thing and that’s who it’s going to benefit. Now, once you have that status, it also allows you to do something pretty crazy, which is that when you sell a property, you have, like we said, you don’t do a 1031 exchange. You’re going to be hit with capital gains tax.
You’re going to hit with depreciation recapture tax comes real estate professional status. And if you get so much deductions, let’s say you buy another property in the year that you sell this one or two or three or whatever, and you have all these massive, mammoth, deductions, you can use those not only to off-set your income, but you can use that, potentially in certain situations, in this one particular to offset your depreciation recapture and capital gains as well.
So, there are options. If you look at real estate as a game and like a strategy and overall picture, as opposed to just looking at it in a box like, okay, I just do one property. and that’s it. So, in a box, you buy it, you get the deductions. Can I use them? Maybe yes. Maybe no. When I sell it, I have to pay tax on it later on.
No, that’s great to understand the principles, but then to understand that there’s a much bigger game. It’s like if you were to play monopoly and all you knew was when you land on something, you have to pay, whoever is doing that, but if you don’t know the strategy behind it. You’re going to be missing out.
Mark: I think that’s a great point that you just made that it’s a much bigger game because I think most real estate investors they get in and they analyze their first property and they say, okay, the income is this amount, the expenses are this amount. Therefore, I get, X amount of cashflow and that’s the game they’re playing. And that’s what they’re totally focused on.
But the longer I do this, I think the debt, the lending aspect of it is huge, enormous. And then the taxation is also huge. So, It’s a bigger game. And if you’re an investor, and if you plan to be an investor for the long term, you need to make sure that the debt strategy is a huge part of your overall strategy. And then also the tax efficiency aspect of it is huge. And they have as big of an impact on your overall wealth growth or possibly even more than just the basic, how much rent did we collect.
Yonah: Yes, absolutely. Exactly.
Mark: Well, cool. And I know you’re a little bit of an investor as well. What else do you do other than a cost SEG?
Yonah: Sure. Thanks for asking. It’s something that’s new to me, but because I’ve been in the industry for a few years, just rubbing shoulders with and talking to every day, with real estate owners and investors, I’ve come to learn a lot more and spend time studying what real estate investing is as well.
And I’ve just come to find obviously that it’s probably the best investment vehicle that exists in my opinion. So, I’ve been feeling it out and trying to find a way into that as well over the last couple years and it’s taken time and just finding the right partners and finding the right markets to invest in and researching that.
Literally just the beginning of this year, back in January, February is when I made a decision to move forward with a partnership with a couple of guys. They had more experience than me, both in the underwriting and the actual, owning properties and multifamily and investing. And they both have a much bigger background in private equity and underwriting. So, finding the right market.
They invest in Atlanta and in North Carolina and both in Raleigh and Charlotte, they own a property in Columbus, Ohio as well. So, I decided, let’s partner up, I can bring value in however I can to just kind of learn, get my feet wet. My First deal, I’ll bring capital. I will do some marketing. I’ll do other things in the asset management in order to help the whole process. And then COVID hit.
I had a deal a 90, 92 unit under contract in Atlanta that was supposed to close at the beginning of April. COVID hit and things got postponed, we pushed it. Didn’t want to see what was going to be happening with the property as time went on and we ended up seeing that. It didn’t make sense. We fell out of contract with that. So, my first opportunity to really get involved didn’t actualize yet at this moment. But, that’s my goal right now to find my way.
Mark: But again, I think the timing of that is great. I was becoming increasingly worried over the last seven or eight years. And in more and more in the last two years is that most real estate investors didn’t think there was such a thing as a recession or as a downturn and much better to get hit with it while you’re still in your contingency period. I did the exact same thing with you. I had a 90-unit building. We were in escrow, we were pre-contingency removal when all hell broke loose and the pandemic, the lockdown, I pulled the plug as well. There was just too much uncertainty.
I was seeing banks pull loans that were well down the road to funding because nobody knew what was happening. And I think, you know, now because you had to put things on hold, you get to watch all this and learn a ton about how the economy can fluctuate. You’re going to see all the risks that were buried over the last eight years in this booming market are now being exposed and you get to watch them as a potential investor, all investors do. And I think anyone who goes through this watching carefully will come away a better investor.
Well, this is great. I have something called a multifamily psychotherapy. If you’d be willing to participate, what’s a trait you possess that has served you best both in real estate and in life.
Yonah: I think the, the thirst for knowledge, like I said, I was a teacher for many years. Education has always been ingrained in me. I love to learn. I love to learn new things. So that has done me a tremendous amount, just that thirst for knowledge, wanting to learn more and more and more and not being satisfied.
Mark: That’s a good trait. Is there a trait that holds you back that you feel like you need to work on?
Yonah: I’ve been working on for a while and it’s a work in progress, but just organization in general.
Yonah: Yes. Just having a lot of different things happening and not being able to be on top of everything.
Mark: If you could pass some advice onto your younger self, what would it be?
Yonah: The advice that I live by. And I think it really speaks volumes. I don’t think I would change it, but I would just reinforce it, which is, apprentice under those who have done experienced life and done things already that you want to do. Don’t try to figure it out yourself and don’t learn in a book because as much as I love to learn, I learn on the job and I learn next to people, following them and speaking with them and doing what they do alongside them a hundred times more than I learned in books. So that’s what I’d say.
Mark: How about, are you ready for our question round?
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