All Forum Posts by: Costin I.

@Laura Van Lenten,

There are two main avenues for conducting a cost segregation study (CSS). The first involves hiring an engineer or specialist, who meticulously categorizes components to maximize segregation and depreciation acceleration. However, this option is considerably more expensive, typically costing 5 to 15 times more than the alternative. For smaller properties such as single-family residences (SFRs) or duplexes-4plxes valued under $1 million, this option may not be financially viable. The potential tax savings, ideally four times the cost, rarely materialize at this scale (why? Because if it costs you $2K to $3K, it should give you ~4x in that in tax savings, or $8-$12K which is not happening).

It's important to understand that a CSS doesn't create additional depreciation but rather accelerates existing depreciation. This front-loading of deductions can be advantageous for reallocating funds, but it may affect long-term tax strategies. For instance, while it can bolster initial cash flow by reducing tax liability, it could diminish deductions in subsequent years (when the property might produce better cashflow), impacting overall tax footprint, so you need to take into account all that in the context of your short term and long term tax strategy (e.g. if you plan on selling soon, at which time the depreciation gets recovered, or not and planning to hold for a long term/forever/1031, buying more later and creating more depreciation to offset cashflow or not, etc.).

The alternative is a do-it-yourself (DIY) or survey option, which costs around $400 to $500 per property (I can do my CSS report in 10min, once I have all the data needed). This method, though not as exhaustive as a professional CSS, is suitable for smaller properties and still yields meaningful tax benefits. Even if not maximizing depreciation, the conservative estimates provided by DIY tools justify the cost for properties under $1.2 million.

Addressing common concerns regarding the DIY option:

1. Ease of Use: Most software for DIY cost segregation studies is user-friendly, requiring minimal input beyond property details. Calculating the depreciation base, typically guided by a CPA, is the primary complexity.

Except figuring out the depreciation base to use (what amount from the total acquisition cost goes for land and can’t be depreciated, and how much goes for the building/improvements to be used in the segregation and depreciation calculations, and even that should be an easy answer to figure out or get from your CPA), the rest is simple stuff your CPA will not know anyway (thus him sending you the “survey”) like, the sqft of the house, the length of the fence and if wood/iron/brick, how many ceiling fans in the house, how many cars garage, if carpet or tile in what room, etc.

1. Audit Protection: Reputable DIY software adheres to IRS guidelines, providing assurance against audits.
2. Time Commitment: Conducting a DIY study does not demand an extensive understanding of tax code or methodology; basic property information suffices.
3. Property Value: The DIY option is viable for properties with improvements under $1.2 million improvement value (acquisition cost minus land allocation), covering most 1-4 unit dwellings.
4. Skillset Development: Given the potential savings, investing an hour to learn the process is justified. Does saving $1-3K is worth 1hr of your time?

There are other questions you should ponder – e.g. can you take advantage of the accelerate depreciation? Do you have the passive income to use for offset? Just because you create the acceleration, it doesn’t mean you can use it – you’ll not lose it, it accumulates for later, but no point in doing it if not able to use it right away. And that’s another discussion.

Allow me to requalify the answer into a set of questions:

• Are you a person who likes to have insight into their tax situation, optimize their tax footprint, and do not shy from tax concepts? If yes, the DIY CSS may be for you.
• Do you get involved in property remodeling and maintenance, track your expenses, and maximize your deductions? If yes, the DIY CSS may be for you.

If you just like to delegate to others and pay “specialists” for your convenience and time, and just drop your papers at your CPA and let him figure out things, you might be better served either by having the CPA do the DIY CSS, or just go without a CSS and the regular linear depreciation.

Lastly: Don’t ask an insurance salesman if you need to buy insurance.

@John Clark, I don't think you can count cap ex reserves as an expense and deduct them. I asked this specific question in this post and 2 accountants weighed in on the issue. Please provide some more info if something like this is still possible.

Thanks @Michael Plaks, I thought it was too good to be true, hence this post, to verify with experts. BP is a great source of information, and at times, of misinformation.

@David M. Thanks, but my question was from the perspective of having these reserves counted as deductible expenses (since is prudent to keep them available) and lowering the tax footprint, as mentioned by @John Clark.

But since you mentioned how to calculate them, this how we do it - I have a google spreadsheet that tracks all the times, with their considered lifetime expectancy and the date the item was placed in service. It's "live" as it updates behind the scene everytime you look at it, since various items might reach their lifetime expectancy and, based on that, should be replaced (obviously, they can fail much sooner, or last much longer than that).

Using that spreadsheet I know what how much I should save in capital expense for each property every month, per year, which ones are past their lifetime and due for replacement, and a total for all properties (if all was to fail at the same time). Obviously, I'm not keeping that large of amounts, but it can add up pretty quick to large amounts. Even if you keep just 20% of expected amount and it's still a good chunk of money to hold in reserves.

@John Clark @David M. - what would you consider "excessive" (or how would you calculate allowed reserves) and how would you set up such a trust or escrow account?

In a recent post about how to minimize the taxes on rental income it was mentioned that: 

Setting aside reserves is an expense, so long as they are not excessive. When you draw down the reserve you count it as income but offset it with the expense causing the draw. Best to put the money into a trust account (or escrow account) for that purpose. The loss of control justifies the expensing of the reserve on your taxes.

As a landlord, I do have to set aside a quite substantial reserve amount for capital expenditures, and it would be great if there is a way to have those funds counted as a deductible expense.  Is the above statement true, and what is the correct way to set up such a trust account?

@Brian Hunsaker - get the Nolo's "Every Landlord's Tax Deduction Guide" book and learn how to track and take advantage of every deduction available to you.

Even if you self-manage and TurboTax, you should have enough deductions and depreciation to minimize your footprint. That is the main goal - to get enough real cash flow in your pocket, after all expenses, and to offset it with deductions and depreciations down to a zero-taxable amount. And to maintain that balance throughout your REI quest.

If not, 1. Congratulations, you have a "good" problem on your hands and are one of the very few to make it to that point of "my rentals are making too much money". 2. Buy more (financed or not) and do a DIY CSS to accelerate depreciation + bonus depreciation to bring down your taxable amount 3. Since you self-manage, create a shell property management LLC and run your rentals management through it, charge yourself pm fees, thus generating self-income, thus being able to open Solo-401K where you can contribute 56K+/year tax deferred (you will have to pay self-income tax, but might end up better than paying full tax on rental income...check with your CPA as this requires planning).

@Max Bellino - it's good you are doing your due diligence before ponying up the money, but do you have assets to protect? major income and/or cash flow? Concentrate on making first the hundreds of thousands in equity (owned equity, not financed property!) and substantial cash flow worth spending thousands of dollars per year on Anderson services and asset protection structures. You are "New to Real Estate" and overcomplicating things, likely years away from dealing with these questions. Become first "seasoned to real estate" and by that time, you'll have enough experience to judge better the asset protection question.

Here are two more bits of advice: 1. stay away from ChatGPT (it might sound authoritative and knowledgeable, but you need to have enough information/experience to critically judge the validity of its "answers"). 2. Don't ask an insurance salesman if you need to buy insurance.

@Don Konipol, correct me if I'm wrong, but IRA's and 401K money are not 100% protected from, or fully for 1. divorce, 2. individual contributions made directly into the funds (vs. as deducted from your salary during your employment), 3. bankruptcy (like, if you move funds into IRA right before declaring bankruptcy) 4. IRS liens and a couple of other exceptions. Just thought might be good for all to know.

Thank you @Michael Plaks. I will use the county ratio applied to the total acquisition cost ($80k building basis and $20k land basis in my example).

Thanks @Michael Plaks. My inquiry is primarily regarding the cost basis - can you elaborate on 
"the different methods of allocating land for CSS purposes" (I don't know how would you use insurance, cause they don't insure the land, nor Zillow does show land/house allocation).

Just to double-check to make sure I get this correctly:

Let's say I get a property for 100K, well below market value.

The county tax assessment for the property is 250K, with 50K land and 200K improvement (or a 20% / 80% ratio).

Which one do I use as the cost basis for the CSS?
a. do I use 50K (my 100K acquisition cost minus the 50K from the county land assessment), 

b. the county assessed 200K for the home/improvement (after all that's what is used to calculate the property tax and I have to pay them) 

c. or 80K, the county improvement percentage applied to acquisition cost (80% of 100K = 80K)