All Forum Posts by: Paul Caputo

@Hector Bilbao I was referring to the 3 rental properties @Adam Sankowski mentioned, not the AirBnb at his residence. 

A $399 "Residential Cost Seg" is not an actual cost segregation. It's filling out a form online and having a computer program spit out numbers based on statistics, not the facts and circumstances of the property. A "residential cost seg" such as this would not hold up to IRS scrutiny. A true cost segregation study requires a qualified construction engineer or architect to perform a site survey, deconstruct the property on paper and reclassify every asset (there are hundreds often thousands of individual assets in a building, even a small rental) which would take 30-40 hours on a small rental and a few hundred hours on most multifamily or commercial properties. 

Chances are you likely wouldn't have a problem or get audited using a "residential cost seg" until the IRS decides to crack down on these providers, but it wouldn't be fun to be the unlucky one who gets to be their example. 

Windows are considered structural and HVAC is considered necessary to the general operation of the building due to it providing human comfort. As such both are long life 27.5 year assets in a rental and bonus depreciation doesn't apply.

I don't think you'd get away with safe harbor on the $1,000 heads since I'm assuming the heads and compressor are part of the same system and were installed together. If each head is truly it's own project and could work without the compressor it may qualify for safe harbor but I don't think that's the case here.

@Adam Sankowski The change in bonus depreciation applies to asset acquisition with contract signed on 9/28/2017 or later. So if you got the property before then the old rules still apply. 

"This only works on big commercial properties" is a big misconception about cost seg. Any commercial or rental property of any size must be depreciated using MACRS. It's just a bit cost prohibitive on smaller properties, and the IRS doesn't mind if you just do it the easy way (the incorrect way) and use straight-line depreciation since that results in overpaying taxes. 

For your situation with 3 small rentals totaling about $200k the cost of a study probably wouldn't make sense. If you had 10-20 small rentals it would probably work. 

As far as using real estate losses against W-2 that's generally no. If your active income is less than $100k you can deduct up to $25k in passive losses, which phases out at 2:1 up to $150k when it's not allowed. If you're a real estate professional for tax purposes that doesn't apply.

@Adam Sankowski if you have any questions about cost seg or bonus depreciation I'd be happy to share my insights and answer any questions. 

What are you curious about specifically? It can seem a bit complicated at first, but once you have experts working for you they take care of all the complex parts.

Bonus depreciation had some great changes, namely the increase to 100% and that used property now qualifies! When looking at real estate all assets classified as 15 year land improvements and 5 or 7 year personal property qualify for 100% bonus depreciation, meaning you can deduct their entire cost in year 1 instead of spreading that deduction out over 5, 7 or 15 years. The real property (structural components) doesn't qualify for bonus depreciation and would still have the 27.5 year for rental and 39 year for commercial property depreciation schedules. To get the maximum benefit from bonus depreciation you need a forensic detailed engineered cost segregation study to find all the 5, 7 and 15 year assets.

Cost seg hasn't really changed with the new tax law other than that the benefits are supercharged due to bonus depreciation. There's still a spectrum of quality and accuracy in cost seg ranging from highly accurate forensic detailed approaches to less accurate statistical sampling and computer modeling. What to pick comes down to your individual situation.

@Douglas Stewart a bit of clarification, please. You said it was built in 1991. Did your father in law build it in 1991 or did he acquire it after that? The year a building was built is irrelevant for depreciation, the in service date for the current owner is when depreciation starts. If he built it and is the original owner then his in service date would be 1991, but if he acquired it later, say in 2000 that would be his in service date and when the depreciation started. A building could've been built in 1850, but if you buy it today a new depreciation schedule starts.

If he's the original owner since 1991 then yes his depreciation benefits will run out next year since it's 27.5 years for rental property. Although I'm sure he'd have done some improvements over the past 27 years so any improvements would have schedules starting from when they were put in. 

He could update the units and would get new depreciation schedules for the new assets, but I'd only do that if he was planning on updating them anyway. Spending a dollar to get fifty cents in tax benefits doesn't really make sense. I bet he could raise rents with updating the units so if it makes sense because of that it's a good move, but don't base it solely on the depreciation.

With something like this I'd be looking into some different complex trust options, which could allow him to sell the property while virtually eliminating capital gains and depreciation recapture, which would be a huge tax hit. 

Doing a 1031 wouldn't start the depreciation over again as that schedule simply shifts over to the new property. The only new schedule would be for assets in excess of the unadjusted cost basis, but with that why not just buy a new property and get the full depreciation benefit? 

If he did place it in service in 1991 that depreciation ship has sailed, if he wants more depreciation he either needs new assets or a new property. New to him, not newly constructed.

@Weina Shi The cost can vary widely depending on the level of accuracy of the study. @Lane Kawaoka$3k-$5k on a $3mm-$5mm property is extremely low, I'd be wary of such a study as it likely relies heavily on statistical sampling or computer modeling. Such methods are inherently inaccurate so they'll either overstate or understate the reality of the property. If qualifying assets are overstated you've opened yourself up to fines and penalties for taking tax deductions that are not allowed. If qualifying assets are understated you've left money on the table so you're still overpaying taxes. The IRS has indicated that they're going to be cracking down on inaccurate cost seg, so it's important to make sure the firm is doing things by the book. The IRS Cost Segregation Audit Techniques Guide, that is ;)

Better to have it done right using a forensic detailed methodology so you get the maximum allowable benefit without overstating or understating. It must be done by qualified engineers or architects, CPAs are not qualified as they generally do not have knowledge of construction, construction techniques, design and estimation procedures. Doing it right costs a bit more, but the additional benefits and peace of mind makes it worth it. 

Cost seg can technically be done on any size property. We've done small properties under $100k up to huge facilities over $1B. It depends on the property specifics as well as your tax situation. If someone is in California and in the 37% federal tax bracket and 12.3% state tax bracket it'd make a lot more sense to pursue cost seg than someone in the 12% federal tax bracket with no state tax. 

On a $725k property you're likely looking at $3.5k-$5.5k to have it done right, but cost depends on the property specifics. Feel free to PM me if you have any questions. 

@Costin I. Absolutely I totally agree with you. I run into a lot of small investors that our service just doesn't make sense due to the cost vs the benefits especially if they're in a lower tax bracket. Different products serve different needs and this is a good example of that. Just pointing out there's a significant difference between the two.

While we do have a lot of clients who invest in SFR's we're usually looking at a portfolio of SFR's in that case, and the majority of properties we look at are larger commercial properties. We just offer the same service to everyone regardless of property size. Some smaller investors want a forensic detailed report and some are fine with a computer generated report. All depends on the individual and the situation.

@Costin I. We quote each project based on the specific details of the property so it varies. That being said if we're just looking at one SFR it's generally $2,500. If we're looking at a portfolio of multiple SFR's there's some cost sharing so the per property cost goes down depending on how many properties. We can generally make the numbers work down to about $100k less land value, and lower if we're looking at a portfolio of 6 or more properties.

There's a big difference between plugging some numbers into an online calculator that generates a report instantly based on statistics and a forensic detailed cost segregation study. A qualified engineer does a site survey to fully document the assets then a team of engineers does a 100% property breakdown using all 32 primary divisions of the building code to produce an accurate report that includes all elements of a quality cost segregation study per the IRS Cost Segregation Audit Techniques Guide with a ready to File Form 3115 if needed. There are no statistics or computer models used. Each asset is looked at individually, costs are adjusted and then rectified with the total property cost. That process takes a lot of time, and qualified engineers don't work for peanuts. 

There's no doubt that this calculator is cheaper than an actual study, but again you get what you pay for. Statistics are inherently inaccurate to the reality of the property, so they've either overstated or understated the allowable assets. If it's overstated you're exposed to fines and penalties. If it's understated you've left money on the table. 

Most people are fine with this since it's such a low cost and the chance of audit is very low. My guess is they limit this to SFR's under $500k and they err on the side of understating by at least 5%-10% to limit exposure. We could put together the same calculator, but we don't because it'll be inaccurate.

@Matt Jones Thanks for the shout out, happy to put in my two cents. I can't speak for other firms or using software for cost seg, but I'd assume that their fees just like ours are fully deductible as a business expense for professional services. It's a nice bonus that the true cost of a cost segregation study is the after tax cost. So if a client is at the 37% rate a $10,000 study would only really cost $6,300, and that doesn't even include the state tax deduction if applicable. 

I'd be interested to check out that webinar. I'm curious as to what they do since it just doesn't seem possible for a computer generated report to meet the standards for a quality cost segregation study.

@Justin Juhan congrats on the investment property! As far as the tax issues go here's what you're looking at. I'm not a CPA so you should consult with yours, but these are the basics for your situation.

Capital gains exemption on personal residence - This is the 2 years out of 5 rule, if you've lived in a home as your primary residence for 2 out of the last 5 years you get a capital gains exemption of $500k since you're married (it'd be $250k if you were single) Meaning the home can appreciate $500k or less and you'll pay no capital gains as long as you meet this 2 out of 5 requirement. Since you lived in it as a primary residence before making it a rental you'll get the full exemption when you sell as long as it's a rental for 3 years or less to still meet the 2 out of 5 requirement. With the new rental becoming your primary residence for 2 years while you fix it up and then move back to your current residence the new rental would qualify for the exemption if you sold it within the 5 year period. You can only use the exemption every 2 years so you wouldn't be able to sell both within 2 years and double dip the exemption.

Depreciation - Whenever a property is "in service" as a rental you must claim depreciation. In service means it's ready and available to be rented whether it's actually rented or not. Some people mistakenly think they shouldn't claim depreciation so they won't have to pay recapture upon sale. This is incorrect since the IRS figures depreciation recapture on what is allowed or allowable meaning if you don't take it they'll still tax you as if you did. Recapture is figured at the lesser of your marginal tax rate or 25%, so if you're in a higher tax bracket you end up repaying significantly less in recapture than the benefit you received. Residential rental property has a depreciable life of 27.5 years. The property is broken down into land value which is non-depreciable and improvement (building) value which has the 27.5 year schedule. So if you paid $100k for a property and it has 20% land value you depreciate the $80k improvement value over 27.5 years for ~$2,909 depreciation expense per year. The first year and last year will be adjusted depending on when the property is placed in service. This is pretty simple for your CPA to figure and the depreciation tables are available online in IRS publication 946: How to depreciate property. 

Depending on the cost of the property and your specific situation it may be advantageous to look into a cost segregation study which will allow you to take advantage of accelerated depreciation and due to the new tax law maybe even bonus depreciation depending on when contracts were signed to purchase the property (after 9/27/17 qualifies for 100% bonus depreciation on assets with life of 20 years or less - the 5 year tangible personal property and the 15 year land improvements in a rental) If you have any questions on how that works feel free to PM me.

Hope this helps.