Business Management

This Investor Paid Zero Out of Pocket for an $8M Apartment—Yes, Really

Expertise: Personal Development, Commercial Real Estate, Real Estate News & Commentary, Landlording & Rental Properties
90 Articles Written
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Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

Love him or hate him, the Real Estate Investor-in-Chief in the Oval Office and his pals inside the Beltway have created more reasons than ever to be a real estate investor. In this simple post, I'm going to outline a straightforward strategy used by a real-life real estate investor who saved $2 million in taxes and landed a cash-flowing multifamily property in the process.

For the past two years, our real estate investor friend (we’ll call him Brett) has had a problem. Most people around the world would consider this a great problem to have.

We live in a wonderful country, and when a profit is made, we have a generous uncle who has his hand out to get his share.

It’s a blessing to make enough profit to owe Uncle Sam $2 million. But it’s a bigger blessing when you make the same profit and owe the IRS zero. That’s exactly what happened in our story.

Preparing for a Huge Tax Hit

For the past two years, Brett was setting aside funds to pay his large multi-million-dollar tax bill. But this year he conferred with a tax strategist who steered him in a different direction. The outcome was stunning.

USA: Traditional Uncle Sam Pointing At You

Do you have a tax strategist? It’s great to have a CPA, but make sure your CPA is a true tax strategist, who will coach you to maximize your deductions and minimize your taxes.

Several years ago, I told the story of Ed, who had been paying over $100,000 annually in taxes. After hiring a tax strategist, he has paid zero in taxes in the decade since.

(I’ve got a great tax strategist I recommend to investors. Reach out to me if you want to know more.)

Realizing the Enormous Benefits of Tax Reform

The tax strategist explained to Brett that under tax reform, Section 179 of the IRS code allows the immediate write-off of depreciation of "personal property" up to the 15-year level. This means that assets that are deemed to be depreciable in 15 years or less through a cost segregation study do not have to be taken in (say) 15 equal annual increments.

They can be used as a tax deduction in year one instead.

Related: Attention Multifamily Investors: Are you STILL Paying Taxes?

If this seems confusing, imagine you could take your tax deductions for the next 15 years and use them all this year. It could create a massive loss—and therefore, a significant tax savings this year. And the loss could be potentially carried over for years to come.

While a self-storage building has a 39-year life for depreciation purposes, the roof, parking lot, shrubberies, light fixtures, computers, gates, security systems, and many more items can be separated from the structure itself and depreciated in a shorter time. The new tax law may allow depreciation all in year one for many of these items.

Taking Full Advantage of Section 179—to the Tune of $2M

Brett is a really successful investor. It was the last quarter of 2018, and he had already set aside about $2 million of his profits to pay his whopping income tax bill due April 15, 2019.

Then Brett started thinking about what his tax strategist said. He realized that if he took that same $2 million and used it as a down payment on a new commercial real estate asset before the end of 2018, that same asset (with a cost segregation study) could generate up to about $2 million in tax write-offs.

Note that due to the role of leverage, he wouldn't have to use all cash to buy the asset. With 75 percent debt, he could acquire an $8 million asset with this cash.

After factoring the (non-depreciable) land—say $1.2 million—out of the $8 million, the cost segregation study allowed the write-off of about 30 percent or so of the cost of the building (i.e., 30 percent of $6.8 million). This generated a year one write-off of about $2 million.

Related: THIS Major Tax Benefit Convinced Me to Put My Money Into Large Multifamilies

So, the $2 million that Brett had set aside for taxes was instead invested as equity in a new multifamily property. Brett’s bank account still had a debit of $2 million, but now he had invested it in his own cash-flowing, appreciating commercial real estate asset rather than in Uncle Sam’s coffers.

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The very property he acquired provided the tax discount and equity he needed to buy that same property.

Too good to be true? Like I’ve said in other posts, if the American people really knew about the tax benefits available to commercial real estate investors, we’d have another tax revolt on our hands.

(Shh!)

Secret concept. Beautiful European female in eyewear, makes shush gesture, asks to keep voice down as suffers from headache, wears spectacles and striped t shirt, isolated over white background

Calling Attention to the Caveats

You knew there would be a catch, right?

First, please realize that I am not a tax professional. Like most of you, I’m a real estate investor and fund manager, who gets to enjoy these benefits. Please don’t take this as tax advice and call me to complain if it doesn’t work.

Second, realize that some of the benefits from accelerated depreciation are best utilized by investors who are designated “Qualified Real Estate Professionals.” In general, this means that you spend at least half of your time in real estate, and it needs to be 750-plus work hours annually.

(Note that some investors reportedly work closely with their spouses to be sure that at least one of them is a QREP.)

Conclusion and Recommendations

Maybe you don’t have a $2 million tax bill. But I’m guessing some of you readers have a $100,000 tax bill.

Will this work for you?

I don’t see why not. In this case, I would look to purchase a property in the range of $400,000 to make similar math work.

I’ve been recommending that a lot of real estate investors stay focused on their day jobs and invest passively in a syndication, for example. Will this work for you? I believe it will.

One of the beauties of the syndication model is that profits and losses flow from the project through the LLC(s) to the individual investor. This means that losses from depreciation (accelerated and regular) flow through to the K-1 of the passive real estate investor.

So, as a passive investor, I would apply this same math. But I still recommend that you check with your CPA or tax strategist to be sure this would work for you—especially if you’re not a QREP.

Non-QREPs still get the deductions, but they may not come as fast.

This is just one of many strategies that real estate investors employ to save on taxes and compound their wealth. By staying involved at BiggerPockets, you’ll hear about many more strategies and tactics, and you’ll meet other investors to guide you and cheer you along on your journey.

You’re in the right place to save on taxes and accelerate your wealth! Happy investing!

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

Have you used this or a similar strategy, or do you plan to this year? I’m always looking for real estate success and failure stories to feature in my blogs, on my BiggerPockets live events, on podcasts, and more. 

I would love to hear from you in a comment below.

After graduating with an engineering degree and then an MBA from Ohio State, Paul entered the management development track at Ford Motor Company in Detroit. After five years, he departed to start a...
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    Charlene McNamara Rental Property Investor from Nevada City, CA
    Replied 9 months ago
    Wow! Never heard about this angle. Wish I knew before Dec 21... Too late for me to buy something this year!
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Charlene, Thanks for your kind words. This should still work in 2020. Happy holidays to you and your family!
    Tim Mikesell
    Replied 9 months ago
    Paul, this may be the most impactful post (for me) I've ever read on BiggerPockets... Kudos!
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Tim, Wow, that is a very nice thing to say! Happy holidays to you and your family!
    JJ GONZALEZ II from Islip, New York
    Replied 9 months ago
    Paul. This is why I invest with you, it appears that you are one of the smartest guys in the room, but you advice is quite simple. So send me the name of a tax strategist or two. Thanks JJ
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    JJ, Thanks for your continuing confidence in our firm. Connecting with you on that via email. Happy holidays to you and your family!
    Tushar P.
    Replied 9 months ago
    So the cost segregation study would change the depreciation from ~175k (6.8M/39) to 2M - is that realistic? Let's not forget depreciation recapture, unless Brett doesn't want to see the money again and is ok with keep investing it in assets (which may not cash flow)...
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Tushar, Yes, I think it is in the ballpark for sure. Yes, he may need to keep reinvesting to keep kicking the tax can down the road for sure. But that is not a bad thing. You know the math on a dollar today vs. the future... Happy holidays to you and your family!
    Mary K. Investor from Ocala, Fl
    Replied 9 months ago
    I would also like the name of a tax strategist.
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Hi Mary, Please connect with me over private message. Thanks! Happy holidays to you and your family!
    Geoff T Fisher
    Replied 9 months ago
    Great article Paul! Had almost completely forgotten about this strategy and it jogged my memory that an Executive Recruiter had reached out to me many years ago to go to work heading the sales team with one of the leading firms in this space (Cost Segregation Consulting), however I did not want to leave my healthcare career at the time. That said one needs to consider/factor in the cost of the cost seg study as these can get pricey and are usually priced in as a % of the tax savings (as opposed to the complexity of the project). Still a dollar saved is a dollar saved!
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Geoff, Thanks for the kind words. The studies often are in the few thousand dollar range as well as about $8-15k for a more detailed engineering study these days. Happy holidays to you and your family!
    Marty Carbajal Investor from Alamo, California
    Replied 9 months ago
    This is an excellent strategy . I’ve used several times with great success. As recently as tax year 2018 I was able to take a $225,000 tax bill into a $40,000 refund.
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Marty, That is AWESOME! So glad you commented here. Great to hear from someone making this work. Happy holidays to you and your family!
    Somit Joshi
    Replied 9 months ago
    Good strategy for tax avoidance in year 1. But in subsequent years he can not take the depreciation expense and pay higher taxes on his multiplex. Right? Thanks
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Somit, That is correct. But that math on saving earlier vs. later is pretty staggering, and it is well worth it. Happy holidays to you and your family!
    Stephen Mair Accountant from Los Angeles, CA
    Replied 9 months ago
    With 100% bonus depreciation, why would you take a 179 deduction? You can take 100% deduction on those same assets and there really aren’t any limitations, which leads me to... You didn’t mention a large limitation of 179. You can’t deduct more than the income earned from your rental activities (IRC 179(b)(3)). It may not matter as much for investors with several properties, but it will likely limit the deduction for newer investors with only a property or two. If your 179 deduction is 5,000 and your income from all rental properties is only 3,000, you cant use 2,000 of the deduction. This limitation doesn’t exist for bonus depreciation. Tldr: take bonus over 179 in most situations. At least until 100% bonus expires (though it’s typically extended year to year).
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Thanks Stephen, It is good to hear from you on this. It sounds like you are well-schooled in the tax arena. Happy holidays to you and your family!
    Larry Hooper Real Estate Investor from Marshall, Texas
    Replied 9 months ago
    Great article Paul. I agree with the strategy to save some of the tax liability, however, you're conflating a tax "LIABILITY" of $2,000,000 with a tax "DEDUCTION" of $2,000,000. The $2,000,000 tax "deduction" is not going to offset a $2,000,000 tax "liability". You would need to purchase a $22,000,000 building with 30% cost segregation to the asset class qualifying for the bonus depreciation and then, assuming a 30% tax bracket, you'd be able to offset a $2 million tax liability. And, you'd need about $5,000,000 in cash to acquire a $22,000,000 building. So, it's not like you're going to be able to simple spend the $2,000,000 and save $2,000,000 in taxes. Larry Hooper CPA.
    Sri Ram Rental Property Investor from West Palm Beach, FL
    Replied 9 months ago
    Paul, Nice article I always look forward to your articles. Keep it coming .I will private message you for the tax strategist.
    Gaspare U. Rental Property Investor from Cranford, NJ
    Replied 9 months ago
    Well done Paul. Very interesting write-up and definitely an eye opener to at the very least have a conversation with a Tax Specialist. Because this one left such a good impression, I will be looking at your previous articles as well! Happy New Year and continued success Sir.
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Thanks Gaspare! Happy New Year.
    Alex Medearis Investor from San Francisco, CA
    Replied 9 months ago
    Another downside of this approach is that you can no longer 1031 exchange the property after the cost segregation study. As a result, you will either need to hold the property until you die or eventually pay a massive depreciation recapture.
    Paul Moore Investor from Lynchburg, VA
    Replied 9 months ago
    Hi Alex, Thank you. I may have missed something here. Why do you say someone could not do a 1031 exchange in this situation? I agree that if someone did not do a 1031 (or use a similar vehicle) then there would be massive recapture and gain. Even in that case, the benefit of taxes deferred and that cash reinvested for years is significant.