017 | Unlocking Tax Savings through Real Estate with Kevin Jerry

Patrick Lonergan: Welcome to the Vital Strategies Podcast, your go to resource for expert insights in the ever-evolving world of tax, finance, and wealth building. Today on the podcast, we’re talking about real estate tax savings. We find many of our listeners and clients own real estate either as investment or as part of their business.
This episode will give you insight into how to lower your tax bill by utilizing some amazing tax savings opportunities that CPAs regularly miss. They aren’t trained to get these deductions. Real estate is a key wealth building asset that also creates tremendous tax savings. Make sure you listen to the end to hear about how, not only are these deductions legitimate, but they are required by the IRS and your CPA still doesn’t know how to utilize these opportunities.
Joining us for this discussion is Kevin Jerry. Kevin is a CPA that specializes in helping entrepreneurs maximize the real estate deductions through their investment properties. He walks us through the steps to make sure that we’re getting the most out of these tax strategies that will help you build more wealth.
I’m your host, Patrick Lonergan, and I’m thrilled to share today’s conversation with you. Let’s dive in.
Kevin, thank you for joining us today. I’m excited to get into this conversation. We believe there’s three pillars to wealth building. We think a cash flowing business that the entrepreneur runs and grows is sort of the main piece. Second is real estate. I don’t know if there’s a better place to hold wealth with what we’ll call the appreciation, the amortization, and then the tax benefits that come with real estate.
It’s a fantastic tool. And we’re going to get deep into that discussion today on the tax benefits of owning real estate. And I’m excited about that. So Kevin, can you just give us a little bit of background about what your firm does, how you maximize these opportunities for clients?
Kevin Jerry: Yeah, sure. Thanks for having me, Patrick. I really appreciate it.
So what our firm does, that’s a little bit different than most other firms. We work with CPAs, work with clients, work with tax attorneys. And we help them to take the opportunities from owning real estate from a tax standpoint, take advantage of every single opportunity there is out there.
We don’t really get into a lot of other assets. We just focus on real estate and buildings because there’s enough business out there and there’s enough complexity and enough confusion on real estate to keep us busy, for the next 50 years. So what we want to do is we help clients really take advantage of opportunities that they may not have heard of their CPA doesn’t really know how to do.
It’s outside the scope of responsibility and skill sets of a CPA. So, we kind of bridge the gap between CPA who does your accounting and you, Mr. Client. We bridge that gap to make sure that the tax side of it is completely covered and that every opportunity that is there, if we can’t take advantage of it, at least our clients will understand what to look for maybe in the future when you can take advantage of that opportunity.
Particularly there’s three or four opportunities that are extremely low hanging fruit that are missed by 90% of real estate investors.
Patrick: I love that. And before our call and I couldn’t align more with this, we were talking about an opportunity that just came up yesterday with one of our clients and you’re like, I don’t care if it saves him $5,000 in tax. Like let’s take advantage of that opportunity and get it into the IRS so that they’re not sending any more money than they have to.
Because I think we both agree that, you know, a dollar goes into the system from a tax perspective and I don’t know about a nickel trickles out to the wrong people after the bureaucracy eats it up.
So I appreciate your perspective on that. And I think you also highlighted another point that, we just feel like the CPA business model is designed for the compliance side of the equation. Like they gather all the client’s data and they file the compliance and we consistently see clients being frustrated by the fact that their CPA isn’t doing tax strategy, but that’s not what their business model is designed to do.
And so I so appreciate how you guys are specialized on the real estate side. There’s a few opportunities that you know really, really well that can maximize those deductions for owning real estate. I’m looking forward to getting into those. So I think there’s probably two, maybe three. If we think about it, there’s a cost segregation study, and then we’ve got the tangible property regulations.
And then out of that comes the partial asset disposition. I know those are all super fancy terms, but maybe we can start off with a cost segregation study and just introduce that concept to our listeners and then dig into why there’s some tax benefit with that.
Kevin: Yeah, cost segregation has been around for about 25 years.
It’s actually pretty simple. So let’s say you own an Airbnb rental and your CPA says, okay, you’ve got to depreciate that rental over its useful life. And the useful life of an Airbnb rental is 27 and a half years. But then I get asked, well, so my bathrooms and kitchens and carpeting, which I know my carpeting is not going to last 27 and a half years.
Why do I have to depreciate that over 27 and a half years? If I’m going to replace it in two years, the answer is you don’t. Well, what would he mean? I don’t. We know you can depreciate your carpet over five years. Then it just starts going, well, what about my landscaping? You know, that’s not going to last 30 years.
No, you can depreciate your landscaping over 15. And my bathroom, I’m going to be replacing that next year. No, you can depreciate that over five years. Then the question is, well, why am I depreciating these components over 27 and a half years if I can depreciate them over five? And. The simple math is the cost of the asset divided by the class life.
So if you have a, let’s say a $10,000 kitchen and you’re depreciating that over 27 and a half years, you’re going to get a very small depreciation expense. But if you depreciate that kitchen over 5 years, that $10,000 over 5 years, now you got $2,000. Over the next 5 years to reduce your income and take that expense.
So what cost segregation does is puts a value on all of the components in a building. That’s all it does. We may have an Airbnb and we have 50 different components, maybe security systems, your window coverings, your moldings, your flooring, your landscaping. And then your roof, your plumbing, your structure.
So that’s what cost segregation does. And then once there’s a dollar value associated with that component, then the IRS allows you to depreciate that specific component over its correct useful life. And the rule is, the shorter, the useful life, the less taxes you pay. So if we can take that kitchen bathroom.
Carpeting, tile, whatever it is, lump it together and depreciate that over five years. Now you’re getting a much bigger depreciation expense now when you need it, rather than having it spread over 27 and a half or a commercial buildings, even worse. It’s 39. Yeah, so this is a way to really take advantage of the time value of money.
And the other thing with depreciation, which very few people understand. It’s not indexed for inflation. So if you have, let’s say a million dollar commercial building and you’re depreciating that over 39 years, you’re getting about $2,200 a year depreciation expense. Every single year you get that $2,200.
But what you’re able to buy with that $2,200, that’s where. It starts shrinking. We think of what a $2,200 would, would have bought 30 years ago compared to what it would buy today. And it’s totally different. So depreciation is great, but because it’s not indexed for inflation, the actual, what you’re able to do with that depreciation gets smaller and smaller and smaller and smaller.
So if you have a $10,000 depreciation expense and you’re in a, this easy math, 50% tax bracket. You’re saving, you’re able to take that $5,000 and put it to work. But in 20 years, that $5,000 is going to be doing a fraction of what it can do today. And so what cost segregation does is it tries to slow that process down and then take the depreciation expense.
And the theory is instead of sending it to the IRS, whatever taxes it’s saving instead, it’s that the IRS keep it, put it to work, give it to you guys, make it work for you to slow down the erosion of that depreciation expense because of inflation. And when inflation was a percent, percent of behalf, who cares now it’s running absolutely rampant.
It’s a runaway train and you have to take advantage of cost segregation that stops inflation wiping away where you’re able to do with your depreciation expense.
Patrick: A hundred percent. And I just think about any dollar that I can take it as a tax deduction today, that I would have to wait a period of time for this is exactly what you’re saying.
If I can move that forward to today, take a deduction and move that into the wealth building category, like that is an absolute win versus letting that dollar sit out there for a number of years, just waiting for it to come into my possession. It’s like, I’d prefer not to do that. So to add another level onto the cost segregation study.
In 22, through the Tax Cuts and Jobs Act, we took all those shorter depreciation schedules and could take 100% of that deduction in year one. That was pretty cool. 23, I believe, we were in 80%. 24, we’re at 60%. Do I have those percentages right? Is that all correct? So we’re losing a little bit of that deduction, but still, I get to take and accelerate it even faster by moving those dollars into today.
So we think that opportunity is a fantastic one as well. So thank you for the insight into cost segregation study. Anything else to touch on there before we move to the next topic?
Kevin: Yeah, it was actually the tax cut and job act was started in 2017. And what you’re talking about, just to make sure that, because I don’t like the term bonus depreciation, because it sounds like more, but it’s not.
So let’s say you buy an Airbnb and you break out the class lives of the components into 5, 15 and 27 and a half. Typically you would be depreciating that five year category over five years. And the 15 over 15 and the 27 and a half over 27 and a half. What bonus allowed you to do was take any class life with 20 years or less and just take it all in the current year, just lump it all in the current year.
And it was great. It was fabulous. But now it’s phasing out, but the house has approved a bill that has a lots of other stuff to it, like child tax credit and stuff. And bonus depreciation is kind of going along for the ride. Now we’re just waiting for the Senate to approve that and details are sketchy, but they were supposed to allow it almost be done retroactively.
So in 2024. We still may be able to take 100% bonus if the Senate ever gets off their chair and actually starts voting for it. So there’s a good chance it’s coming back.
Patrick: Good. And this is something that I think is important too. So let’s go back, let’s say 2019, I bought a property. I can still do cost segregation study and I can go back and amend that tax return and get some, I’ll say bonus depreciation used back then. Is that accurate or am I making that up?
Kevin: You’re halfway there. So yeah, you can go back retroactively and take the additional depreciation that cost segregation would have created and you could pull it into the current year, but you don’t have to amend and you don’t have to open up those tax years. It’s a code section.
It’s called 481A. And you don’t have to remember that, but what it is that the IRS says, you’re changing your method of accounting for depreciation from straight line to this new method called cost segregation. The IRS says, when you have an old method and a new method, and at some year, they’re going to intersect.
And that year that they intersect, there’s going to be all kinds of inconsistencies, so the IRS says, don’t do that. Don’t amend returns. Just go back in time to 2019 when you bought your building. Apply cost segregation retroactively. Calculate the reduction of income that you would have had from 19, 20, 21, 22, and 23, and just bring it all into the current year.
Total them all, bring it into the current year. It’s called a negative 481A adjustment. And a negative is good in this case because a negative reduces your taxes. So it’s a phenomenal opportunity. Yeah. You’ve got to fill out some tax forms and we can do that. Or you can do that. Or your CPA can do that.
But the great news is you can go back retroactively and never amend or return. Nobody wants to, I don’t want to amend or return. That’s like waste the red flags to the IRS. So we want to kind of fly under the radar, but still take advantage of it. And that’s where 481A comes in. We take off segregation, apply it to day one.
Total up all the reduction in income and the reduction in tax you would have paid, and then take that big giant deduction and bring it into the current year.
Patrick: Fantastic. I love that. Thank you for the clarity there. That sort of makes it even better than I thought it was. I thought we had to go back and amend, but the fact that we don’t have to pay the preparer and Thank you for the clarity on cost segregation study.
I think it’s fantastic. I think a few pieces to outline there that sometimes people miss is through cost seg, you can actually create more loss than you have income to offset it from a passive perspective. Now, we love when, if I had a perfect design. There would be one spouse that’s the business owner runs the operations of the business.
The other spouse is a real estate professional. Now I can offset all of the losses on the real estate side against my active income. So if I get $200,000 of what called depreciation that got all shoved forward into that first year. Now I can offset $200,000 of taxable income out of the business from that.
Where if I’m not a real estate professional, I sort of have this loss sitting over there that just takes me a while to soak up through my regular cashflow from my passive activities. And so that can be a frustrating situation when a client thinks they’re getting a huge deduction. They get it right off their active income, but then all of a sudden they don’t.
So we like to be careful. Let’s only do some of these accelerated strategies if we’ve got the ability to offset the income or we’ve got a big passive income out there that we’re trying to get rid of. Yeah, I think that piece matters. That’s my little asterisk on the discussion.
Kevin: It matters a lot. I mean, you don’t want to have a loss that’s sitting there and suspended until you may take five years to get through that and you’ll pick it up and you sell your building, but nonetheless, you’ve got to pay our firm a fee to do this.
And you’re not getting an immediate benefit because you don’t have the income to offset that depreciation. I won’t do it. Unless there’s an immediate benefit, call somebody else, but I’m not doing it. Having you pay me and get the benefit five years down the road. That’s not what we’re about. The interesting thing with that though, Patrick, is there’s a, I don’t even loophole.
I hate that word, but let’s say you do own an Airbnb and you do offer services. And you do the average day of seven days or less. Now the IRS says that’s not a rental property. So you don’t have to be a real estate professional to take advantage of all the additional depreciation, because this is now a business.
It’s like a hotel. And the rule is if it’s a rental property, you’ve got to be a real estate professional to take advantage of the additional depreciation to offset your other income. But when you run a business, that’s not the case. So at Airbnb is going to be on a schedule C, not a schedule E. So it’s not a rental property.
So let’s say you do have $50,000 in income and we create a hundred thousand dollars in depreciation. If you’re running an Airbnb and you’re running a business and you materially participate, which is a whole other conversation. Now that depreciation can offset your other income. I always tell my son, you can’t marry for love or money.
Marry a real estate professional. It’s the greatest thing in the world. But sometimes that just doesn’t work out. But if you’re running an Airbnb, at least for now, those rules are kind of off the table.
Patrick: Yeah, I agree. And I’ll say I stumbled into the real estate professional side of things. I started investing in real estate about 20 years ago, recruited my wife into the business.
Now she runs the real estate side. We’ve got about $150 million of real estate in three states and we keep acquiring. So we keep getting new opportunities to create new deductions and it offsets not all, but a lot of, we’ll call it active income out of this business. I love that strategy.
Kevin: Yep. No, me too.
You guys are doing everything right and whether it’s intentional or not, you did a great job setting the stage to be able to take advantage of these tax laws.
Patrick: All right. So let’s move into the tangible property regulations in 2014. We got some new regulations there that I think opened up some opportunities that I think are often missed through major renovations and improvements that are done to property.
Can you talk a little bit about what the opportunity is there with the tangible property regulations?
Kevin: Yeah, the tangible property regulations, the concept is actually pretty simple. You own a building. You replace a roof, the roof’s 100 grand, what does your CPA do with that $100,000? Now, he can expense it in the current year, which is wonderful, just to be able to take that 100 grand and just write it off on your taxes in that year.
Or does he have to depreciate that? In this case, it would be over 27 and a half years. Obviously, you don’t want to take that $100,000 and spread it over 27 and a half, because now we’re going right back to what we talked about with cost segregation. You’re depreciating it, you’re getting a small amount of income, but inflation is certainly wiping away what actual cash benefit you’re getting from that depreciation.
It’s the same thing, but these regulations in a lot of cases will allow you to expense it in the current year and not depreciate it over 27 and a half. And there’s lots of facts and circumstances around it, and it’s super complicated. But, it’s a real opportunity. And the interesting thing is Patrick, these regulations are mandatory.
You have to follow these, but then you look, it’s like, okay, I have to follow these, but is anybody enforcing these? And the answer is no, at least right now, they’re not enforcing it. So what CPAs will do, and I don’t want to say it’s the wrong way, but it’s the way we were all taught is when in doubt, just depreciate it because it’s the most conservative way that you can handle a client’s expenditures just depreciate everything because the tax benefit from depreciation is actually small compared to an expense.
But then, so you fly under the radar, the IRS is not going to bother you. It’s like, okay, I don’t need the headache. Someone’s appreciate everything. Meanwhile, your client is severely overpaying their taxes. So, yeah, in your mind, you’re mitigating the risk. But meanwhile, The client is overpaying taxes to be able to mitigate that risk.
And so these are mandatory, but they are so taxpayer friendly, which is strange. You know, when was the last time you heard of a mandatory IRS regulation that actually saved taxes? And the answer is never. It never happened, at least not in my lifetime, but these are different. These are mandatory. They’re often ignored because they’re so complicated.
There’s example after example, after example, there’s no, if you did this, take this deduction. If you did that, take that deduction. It’s a hundred different examples, and you’ve got to find the facts and circumstances and line it up to the best example you can find. And what if you’re wrong? What if you expand something and the example didn’t really make a lot of sense compared to the facts and circumstances?
Now the CPA’s got risk, and they’re not willing to take that risk because you don’t pay them to take that risk, it’s not in their contract to take that risk. So I’m not taking the risk. If I don’t have to, depreciate everything. Meanwhile, you got mandatory regulations out there that will actually save you taxes, but somebody has got to do the work and that’s what we do.
Patrick: Yeah. I think you hit on a few points there that I want to talk about a little bit more. So the mandatory side, it’s a ton of work to do that piece. Like when I think about the CPA business model, it is a high-volume business. And if I were to stop and go, Oh, okay, I’m going to look at the a hundred different examples and see if this thing fits into any of these.
And then I don’t know, but my guess is the mandatory requirements or some ream of paper that requires me to fill out a bunch of forms to take advantage of all of this. So that’s the first piece. My guess is it’s time intensive and complex. And so it’s like this doesn’t fit in the business model. Then on the other side of the business model, it’s like, if I get audited as a CPA, that causes me time energy, potentially the IRS can come and find me for some of these things.
And so it’s sort of a double win for the CPA and a loss for the client. Like it’s a double win. It takes me less time and I’m less likely to get hung up in some sort of audit because I’m unfamiliar with this strategy, but the client pays more tax, but that’s not necessarily my problem. Is that a fair assessment of why we end up in this situation with the CPA is just taking the easy route.
Kevin: It is. That’s exactly what happens. These regulations have been, the IRS has said these take between 800 and a thousand hours to learn. These are from 10 years ago. And meanwhile, the tax code changes every single day. So CPAs have this mountain of learning and this mountain of changes every year.
And now we’re asking them to go back 10 years and learn a regulation from 10 years ago, when you’ve got 20 regulations from 2024 already that they have to learn. So it doesn’t happen. But meanwhile, CPAs are a business and they have to get these tax returns out. So they don’t have the wherewithal. They don’t have the staff.
Even the big four doesn’t have it to be able to dig deep down, find regulations from 10 years ago to help a small investor save taxes. It just doesn’t happen. It’s not possible. So it gets ignored. And depreciation, their theory is I don’t have to worry now. It’s interesting. There’s a code section called 1016-3.
It’s called use it or lose it. So what the IRS has the ability to do, and they haven’t done it yet, they’re not enforcing it yet, but they can, is they can disallow future depreciation. Let’s say you’ve got that roof that we talked about, and that roof is being depreciated where the regulations, if you follow them, the roof would have been expensed.
But it’s being depreciated for whatever reason the IRS can say, no, you’re manipulating your income. This should have been expensed, not depreciate it. And we can disallow all the future depreciation on this. So even if you get it wrong, the IRS can still come back and haunt you.
And then what’s even more interesting, and I don’t want to be that dark cloud and I don’t want to be the chance of rain here, but they have a 27 and a half year roof. That’s being depreciated over 27 and a half years. The IRS has 27 and a half years to go back and disallow that. Wow. There’s no three year statute of limitation on real estate assets. Courts have ruled that the IRS can go back anytime during the life of that asset, which is 27 years.
And come back and say, remember way back in 2024, you guys screwed up. You should have expensed this. You depreciated it. We’re going back to 24 and just buying the stuff. So will it happen? Probably not, but it could. So there’s a risk. Even depreciating it, if you don’t follow the regulations, you have a risk that could happen, Patrick.
Patrick: That’s fantastic. So it’s sort of the third reason why you should execute on this strategy versus just let it go. You know, it’s required, it might be a lot of work for your CPA, but the IRS can come back and cause you massive problems in the future. So I guess the question is, let’s say it’s somebody’s listening to this in 22, they put that $100,000 roof on their apartment building.
Is the opportunity to use the tangible property regulations and expense that gone? Since we now selected the capitalization depreciation side of the equation, do we miss that opportunity?
Kevin: No, and that’s an awesome part of the tax code. Just like cost segregation, what you’re able to do is change a method of accounting where cost segregation, you’re changing the method up straight line to cost segregation.
With these, you’re changing the way you handle repairs and maintenance. And changing it from the old way to the new way, and the new way is a tangible property regulation. So, we can actually use 481A again, same thing. And we can go back and say, okay, this roof was depreciated, we’re going to expense it.
Okay, and then how much tax savings would we have had over the last couple of years if we expensed it rather than depreciating it? Add those up, bring it into the current year, and take the deduction. So we can actually go all the way back, I don’t know, the year 2000. Sure. If there was a roof that was done.
And so the way it works is we can bring forward the deduction of the original amount of the roof replacement minus any depreciation that was taken. We can bring it and pull it into the current year, a negative 480 adjustment. And the older it is, the more depreciation has been taken. So there’s less to pull forward.
But in your example, there’s only a couple of years. So it’s almost as if it was brand new, almost take the entire cost and bring it into the current year and take a one time deduction of it. And it’s funny because you have to do that. That’s mandatory. You have to do it. Yeah, this is not a loophole. This is not a gray area.
This is not optional. You have to do that. And it blows my mind that you got an opportunity to save money. And the IRS says you have to do it. And the CPA is like, nah, I don’t want to do it. You have to, and you’re saving money. I don’t want to do it. So that’s what we end up with.
Patrick: That’s fantastic. I could argue, even if you’re halfway through the depreciation schedule.
Take the other half and move it into today. Like there’s no downside in doing that.
Kevin: No, there’s absolutely none. There’s a huge downside to not do it. But yeah, just do it. Three quarters of the depreciation we were talking about. Would we do work for that’s 5, 000 savings to the client all day, all day long.
So if it’s more than a few hundred bucks. Do it because it all adds up and if the opportunity is there and don’t send Caesar more than Caesar deserves.
Patrick: I love that. Absolutely. So thank you for the dive into tangible property regulations. Now, I think that leads us to the partial asset disposition study, the PAD study.
Can you walk us through what the pad study is and how there’s benefit there?
Kevin: Yeah, sure. Partial asset dispositions are missed so much and of all of the things we talked about, that’s probably the biggest tax opportunity. So let’s go back to our roof example. Okay, you own an Airbnb and you replace the roof and the facts and circumstances are such where that roof has to be depreciated.
It’s a hundred grand and the way these regulations work, if you make the house bigger, better, faster, stronger, or impact a very large portion of it, it has to be depreciated. So there’s nothing you can do. We can’t expense it. But what about the asset is a building and within that building? Is the value of all the plumbing, carpentry, framing, concrete, everything’s in the value of that building.
When you take a portion of that building and you get rid of it, and it’s not even a building, any asset, if you take a portion of the value of that asset and you throw it away. You can take a one time expense of what that original value was. So the value of the original roof, in this case, minus depreciation, can be expensed.
So you have to depreciate the new roof. Nothing we can do. You got to depreciate that over 27 and a half years. But then what’s the value of the old roof? Well, the old roof as if it was new is probably right around a hundred grand again, depending on how the real estate appreciate it. Let’s say it’s 80 grand.
And then you get rid of that. You can take that $80,000 and you can expense it. I love it. Because if you don’t think about this. Now you’re depreciating two roofs, you’re depreciating the original roof, which you did not expense and you’re depreciating the new roof, which you also did not expense. They’re both being depreciated and yet one’s in a landfill somewhere.
Why are you depreciating a roof that’s in a landfill? If you can just take in the one time expense of that. And the reason is because it takes engineering work to calculate the value of the old roof and all the screws and all the metal things. Whatever you threw away, somebody’s got to put a value on that.
And that’s what we do at kind of as an engineer. So this really does require some basic engineering, but again, it’s called a ghost asset. So if you’re depreciating two roofs, one of those roofs is not there and it’s called a ghost asset. And it’s like, okay, well, yeah, I have to appreciate two roofs, but here’s the killer.
You have to pay depreciation back when you sell your building. It reduces your basis. So your larger capital gains is more. So now when you sell your building, you’re paying back the depreciation on a roof that you haven’t had in 10 years. It’s in a landfill and that’s the killer of it.
Patrick: Absolutely.
Kevin: Yes, you don’t get a one time deduction in the current year, but then you get this double whammy where you got to pay two roofs back when you sell your building.
So the code section 168 says, take the expense all day long, but you’ve got to do it in the year that the roof. Was disposed of. If it was disposed in 23, you file your taxes for 23 and you move on, you can never take it again. So if you’ve done, if your clients have any renovations, improvements, and there was a dumpster sitting outside and guys with sledgehammers making a bunch of noise, they need to contact you.
Patrick: Sure. I love that. I think there’s a couple of things that need to tie together here though, to make sure we get that deduction. So we talked about the cost segregation study at the beginning of this tax piece. The cost segregation study is really important to be able to get the PAD study, if I’m not mistaken, right?
Like, that gives me the value of all these component parts. So, if I put a new roof on, the roof is outlined in the cost seg as to what the value of that piece is. And so, Now I’ve got a figure that I can go, okay, cool. That thing we just tore off. Here’s the data that says this is what it’s worth. It’s in the landfill now.
Now it’s an expense that I get to take. Is that correct?
Kevin: 100%. Yeah. The IRS says they use this word a lot. Reasonable. Is it use any reasonable method to calculate what that roof is worth? But a cost segregation study is the preferred method. Yep. Because somebody’s got to put a value on the roof and it’s just not the lumber.
There’s a lot with a roof and you start getting into complex renovations where you’re renovating an entire floor of an office building. I mean, there’s hundreds of components. So the IRS is anything reasonable is fine, but a cost segregation, that’s what we prefer. And then that makes it just easier on everybody and it becomes defendable.
The IRS questions it. Well, how’d you come up with this value of the roof? Well, a third party engineering firm with cost construction calculated it. There’s no refuting that.
Patrick: Yeah, no, that’s great. And we really do like to be on the right side of the IRS. All of our documentation matters. So let’s say somebody doesn’t have the cost seg.
I’m probably a little nervous about assigning a value to that roof that we threw away. Is there other justifiable ways to put a value on that roof that we just got rid of?
Kevin: Yeah, again, as long as it’s reasonable, you could actually figure out how many squares that roof has calculate. Okay, 5 years ago, when we did this, what’s a square of a shingle roof cost and then just use the producer price index and calculate what inflation was between when you bought it until now.
And you can do those complex calculations and it would be reasonable, but you’d miss 50% of the benefit because there’s all kinds of other ancillary things besides the shingles or a membrane that go into a roofing system. So yeah, you could probably take the low hanging fruit, Patrick, but you know, you’re going to take that one orange, but you’re going to miss the 10 oranges that are above that because you didn’t take it the whole way.
And besides cost segregation, especially when you start having multiple components of a building that are thrown out, we’re only talking about the roof. But what if you have to redo windows? What if you have to redo plumbing? What do you have to throw out electrics? What if you have to dig up a parking lot and get rid of that?
That’s where it gets real complicated, but that’s where the tax opportunity is. And the only way I can think of is to have a cost segregation study done.
Patrick: Fantastic. I love it. Now, if it’s okay, I’d like to look at a few examples that we could just think through. So I’d like to start off and just say, we’ve worked with a client that you didn’t create a million and a half dollars of deduction.
You saved a million and a half dollars of income tax for a client. I think that was just in year one. I think there was subsequent savings after that. So the power of the work that you do, and this was a real estate investor that was deep in the game and it was cool to see that you could show up and bring value that he was completely unaware of.
So, I just want to throw that out there to all the listeners that think they’ve got all their tax strategy dialed in. I think you need to be in touch with Kevin and his team to make sure that you’re not missing anything. Cause I’m pretty sure this client thought, yep, we’ve got it all sorted out. And there was just additional dollars that we were able to bring into the equation. So that’s fantastic. I wanted to put that out there.
So we’re personally buying a hospital site. We got a great deal on the land, the value alone, even if the hospital wasn’t there was an opportunity. We’re going to put 150 units on the site and then we’re going to turn the hospital into an additional 50 units.
So right now that hospital is not being utilized. That’s not in service. Can we just walk through some of the opportunities that are available for this project in general? And I don’t need specifics, but I’m just wondering what we need to do to take advantage of some of these.
Kevin: Yeah, sure. So the caveat to what you’re doing.
Is you are buying the hospital and then you’re immediately renovating. You’re not putting it into service and then renovating it.
Patrick: That’s correct. Yep. You can’t. It doesn’t make any sense. Right. It’s not livable.
Kevin: So what you’re doing, the opportunities would still be very, very good, but not as good as if you bought the hospital already in service and then started renovating.
I’ll explain why. So in your situation, you’re going to have the original building, which is the hospital and then all the renovations and they’re going to be combined and you’re going to have a basis in that hospital and the basis is the original value minus land plus the renovations. Now that becomes what you depreciate.
So we can segregate the original building and we can segregate the renovations, meaning put a value on all the different components and depreciate them separately, rather than over, in this case, it’s 39 years. Then we can also take the cost of removal. The removal costs under the tangible property regulations, which is a completely different section, says you can expense the cost of jackhammers, the cost of dumpsters, the cost of guys with sledgehammers, all that stuff.
You can expense that. And although we cannot expense what you disposed of from the old hospital, because the rule is that the building has to be in service before you do that, like I said, some cases, you can keep it in service or put it in service. Some cases you can’t in your case, you can’t. So we have a kind of a 3 prior approach.
The original building removal costs. And then the new renovations. Now, if this was in service before you did that, now you have the original building, you have the renovations, and now you have the partial asset disposition expense of everything that was disposed of. But the building has to be in service.
And again, sometimes it just doesn’t work out that way, but three out of four ain’t bad.
Patrick: Yeah, absolutely. That’s wonderful. And I just think bigger picture, like, okay, once we get done building everything, we do cost seg on the entire project, and then we’re pushing a bunch of that depreciation forward. And again, we’ve just seen it work over and over again.
It’s just offsetting so much of our taxable income that come through the active business side of things that it almost feels like cheating. But I think about how the IRS structures the tax code. It’s designed to incentivize behavior. The government has figured out they’re no good at building property and being landlords.
And so they’re like, okay, we’re going to incentivize the general public to do this by creating this tax incentive. And it’s just my obligation as a taxpayer to use that to the fullest. So I’m excited about everything that we’ve got going on there. So moving to the next example, if that’s okay. We’ve talked about a client recently that’s buying a building and he wants to start renovation immediately.
It is something he could put into service. He could start utilizing some of the space. So can you talk us through like what the benefit of that in service pieces and what sort of that means for the opportunities that they can take advantage of with the work they’re going to be doing to this project?
Kevin: Yeah. In service data is critical. So your client, when he buys his building, And he’s got a certificate of occupancy, you know, he’s got electrical plumbing, all that stuff going to it. His CPA can put that in service and in service. The IRS says it has to be ready for its intended use. It doesn’t have to be rented.
Doesn’t have to be anybody in. It doesn’t have to be making money. It just has to be ready for its intended use. And in this case, it was. Was that a residential rental or was it a commercial building? Do you remember?
Patrick: Yeah, it was a commercial building. It was formerly a Walgreens.
Kevin: Okay. So the intended use of whatever this client’s going to do with it, but once he buys it and he closes and it goes into service, the CPA can start depreciating that immediately from that day forward.
As long as he’s got a certificate of occupancy and then people could rent it if they wanted to, if they wanted to pay, they could rent it. It is rentable. That’s not even a word, but it should be. So you’ve got a building that’s in service and now it can be depreciated. And now your client is going to start renovating.
So because it was in service, now we can take advantage of that partial asset disposition under 168K and that we can take everything that he disposed of and expense that then we can expense the cost of sledgehammers and dumpsters and that stuff. We’d expense that and then we can cost segregate, put a value on every single component of the new renovations, change the class lives and reduce his taxable income on that.
So this is one of those four prong approaches where the stars are, I know it’s a mixed metaphor, but the stars are just aligning. All four have aligned perfectly, which is actually kind of rare. So your client has an enormous opportunity to wipe out his taxes, certainly from this building for 2024 probably 2025.
He’s not going to be paying taxes. And again, this is not risky. This is in law. So it’s not like, well, yeah, we’re going to save him taxes, but he’s going to be up night worrying. He’s going to be wearing pinstripes for the rest of his life. That’s not the case because at the end thing that also I always say in the back of my mind, Congress, Congress made these rules up.
The IRS doesn’t make rules up. Congress makes them. And it tells the IRS just to implement them. Well, what’s Congress made up of? They’re all wealthy real estate owners. What a surprise, you know, and you throw rocks at Donald Trump, but he’s not paying his taxes. Donald Trump’s following the law set up by Congress.
And if you look at the net worth of politicians that they all, the longer they’re in office, the more their net worth goes up and they all own real estate. So these laws are from Congress and they gave them to us and said, you guys figure it out. But we have, and you have. So now we have the opportunity that Congress has given us.
And if it applies to them, it applies to you and I.
Patrick: Yeah, that’s wonderful. I love it. And then I think the last example that we could take a look at is this is a small deal, but I think the small ones matter. You’re like, if we don’t have to send five grand to the IRS, let’s do it. So this is an example. A client had two office spaces.
They decided to tear down a wall in the middle and put up like a glass wall, like I have behind me and furnished it, made it look really nice. So he spent about $25,000 on just remodeling the space, not furnishing it or anything. Can you talk through, like, what kind of opportunity would be there out of that $25 000?
Let’s assume some of it’s drywall, but a lot of it’s, you know, going to be things that we can sort of break the cost out. And is there opportunity there for some deduction?
Kevin: I think so. I would do it. So you put a glass wall in and it’s $25,000, but what does that $20,000 really encompass? Yeah, it’s the glass.
But it’s the labor and it’s the ripping out the old stuff and it’s getting rid of the old stuff. And so there’s a lot of demo in that $25,000. It’s not just the glass. So we can do a couple of things. We can expense the cost of the demo. And a lot of general contractors don’t like showing you the demo cost because they make so much money on the removal.
They don’t want you to see that. So they bury everything in it to an invoice. And I would do the same thing that says 25 grand, but I’m not showing you that the glass was only $2,500 bucks. And the rest of it is pure profit from the demo. So you could expense the cost of the demo. And if your general contract to ask him separate the asset to the demo, so I can expense the demo and then he’ll be okay.
He won’t like it, but he’ll have to do it. So you can expense the demo. And then if there was drywall and there was flooring that had to get ripped out and maybe some framing had to get ripped out, or God forbid, there’s a load bearing and it had to get ripped out, which I highly would not suggest doing it.
But nonetheless, you can calculate everything that was thrown away. So maybe we can create a, I don’t know, $15,000 expense for this guy. And if he’s in the 37% tax bracket for federal and 6% for state, or if he’s in California. God only knows what it is for state
Patrick: 52. Yeah.
Kevin: When you’re saving four or five grand for $5,000.
Patrick: Yeah, absolutely.
Kevin: So this is the way I always think about this. If I was walking down the street and I had five grand in my pocket and somebody robbed me of that five grand, would I be upset? I would be livid. I would be inconsolable. Yep. So why are you not taking advantage of this when it’s right there?
It’s legal. Somebody just has to do the work. And then you’re still going to save that five grand, why would you not take advantage of that? And you start putting it in context. It’s like five grand is a lot of money. I don’t care who it is. It’s a lot of money. So don’t give Caesar more than Caesar needs.
Patrick: Absolutely. I love it. Kevin, this has been a wonderful conversation. You brought a lot of light to how to take a real estate asset that a lot of our clients own and create more tax opportunity through everything from the cost segregation study, tangible property regulations, and PAD study. This has been wonderful.
I think we could have probably spent a whole episode on each one of those topics. We’ll probably have to have you back in the future to dig in a little deeper, but we appreciate your time and energy and we look forward to connecting with you soon on all of our clients tax opportunities on the real estate side.
Kevin: No, thanks for having me. I love these things. I was with Hewlett Packard for a long time and another lifetime. And Carly Fiorina said, there’s two kinds of taxpayers, uninformed and informed. And uninformed always pay more than informed. So what you’re doing is wonderful, Patrick, you are informing, you are educating so that a taxpayer and a real estate owner or investor can at least understand the basics. And then he, once he’s educated, then, you know, it’s completely up to him. So good for you for the education here, Patrick, because it’s priceless.
Patrick: Fantastic. Thank you so much, Kevin. I appreciate you. You have a great day. You too.
Kevin: Bye.
Patrick: Thanks. Bye bye.
Thank you for listening to the Vital Strategies Podcast and our conversation with Kevin Jerry.
For links to the resources mentioned in today’s show, See the show notes of this episode at vitalstrategies.com/episode/17. If you’re feeling overwhelmed by the money that you’re sending to the IRS and want to pay less tax, go to 5minutetaxmakeover.com to download the free resources that are designed to help entrepreneurs.
Save up to $10,000 in income tax or more. Visit 5minutetaxmakeover.com to start paying less income tax today.