You have stumbled on to another episode of Get Your FILL – Financial Independence, Long Life, where we explore ways to achieve those two goals.
Today is part two of our conversation with Jeff Hiatt.
If you missed part one, it might have cost you money. So go back and find it. ’cause Jeff is an expense reduction consultant. He and his team at Performance Business Solutions LLC, help business owners and property owners to reduce expenses and increase profits. Jeff, what’s the good news for property owners who are just discovering segregated accounting?
J: And the good news is even for the properties they’ve owned, the IRS allows you to go back in time. So even if you’ve owned a property for 5 or 7 or 10 or 12 years, you can step back in time and grab that depreciation without having to amend your tax return.
Because to amend, you only can go back three years. but the IRS allows you to use what they call it form 3115, which is the Change in Accounting Method. So instead of doing straight line depreciation you’re changing the accounting method to accelerated and you use that change form and it’s automatically accepted by the IRS. You don’t have to amend your tax return and you grab the three or five or seven years’ worth of depreciation, all in the current year, so that’s a big pick-up there. So that worked out nicely.
C: Yeah, that’d be a nice little check.
J: Usually it’s not a check back.
C: it’s just a huge reduction in your taxes.
J: Correct, you have it as a loss for this year all that depreciation and it reduces your current year income tax, and then anything that you can’t use in the current year, you get to roll forward in the next year so that works out nicely too.
C: Yes, very… Oh yeah, that’s good… Good tip, good thing to know. Yeah, ’cause all the people who are listening, who are saying, like… Oh man, I wish I would have known this when I bought my building. They can now go back.
J: Exactly, yeah, as a technical point, you can go back to ‘86 when the tax law changed, but usually you don’t go back that far. Usually the benefit – because the accountants will tell you – this is what they call… What the accountants call a timing difference.
In other words, I’m not giving you more depreciation you’re getting the same depreciation, it’s just you’re getting it sooner.
Well, the benefit of that, the timing benefit of that is usually achieved in the first 10 years. You might go push it out to 12 years, but that’s really kind of the window that is most frequently looked at for these. So we would typically get depreciation schedules, because that’s all we really need for those existing buildings.
All we need is a copy of the depreciation schedule, and if we can get a copy of the depreciation schedule, then we can do a Google search on the building, look at that building. It’s a five-family in Salem, New Hampshire or wherever… Boston, Mass or Brookline… Or whatever.
And we can then break apart what we would think as an estimate and we know – Oh, look at that. The depreciation says they paid $180 grand for it, in 2017 – here’s what that benefit would look like, and they can know roughly what the tax benefit is gonna be before they spend a nickel. That works out.
C: And what’s the impact when they… I’m assuming that when they sell it, if they sell it seven years in, or something like that, that they’re gonna have perhaps a larger tax burden at that time, right? As far as… ’cause they’ve depreciated more of the building. I’m obviously not on account.
J: Yeah, so you do have recapture come back into play and that will be in play, whether you’re doing straight line or accelerated what would be different would be there would be more recapture with the cost seg so you might have to give back some of that tax benefit depending on when they’re doing it, and how the accountant is attributing values to everything but a lot of clients in the real estate space especially, they’re gonna do what they call a 1031 Like Kind Exchange So if they’re doing 1031 anyway, which is deferring the gain, what would end up happening is they would do that 1031 when they sell and the recapture never comes into play because you’re deferring the gain and you’re not having to deal with that. So the recapture conversation wouldn’t pop up then.
C: Yeah, but it’s obviously… I mean you wouldn’t do it on any kind of a short-term thing anyway, so obviously your future plans for the building have to come into play when you’re making the decision whether you wanna go this route.
J: That’s absolutely correct. So if we would say to you Christine if you’re only planning on holding this building for a year or two because you’re gonna put paint on it and fix up the apartment units, and sell it real quick and then this does not make sense to do unless you’re gonna do a 1031 and then it would because if you’re doing the 1031, the giving back of that tax benefit does not come into play.
If 1031 is on the table, then any amount of hold time is fine, but if you said, “I hate 1031s for whatever reason, I’m not doing a 1031“. then we would say, need to hold it for at least three to four years before it is gonna make sense without a 1031.
Now, keep in mind if you’ve already owned the building for three or four years or five or seven years and you do a cost seg and you’re not gonna do a 1031 then it does make sense. So I’m talking about just the hold time, not the time you’re gonna hold it beyond having completed the cost seg,
C: Yeah, it’s interesting. I mean, I don’t know why anyone wouldn’t want to do it. Is there anybody who shouldn’t beside somebody who’s thinking of selling, in a couple of years. Are there scenarios in which it really just doesn’t make sense for some particular type of investor or type of building or anything?
J; Where it wouldn’t make sense – there’s a couple of times it wouldn’t make sense. Like you said, if you recently bought it, and you’re not gonna hold it for more than a couple of years and you’re not gonna do a 1031, then that doesn’t make sense to do.
Okay, so if you’re gonna buy… I’m gonna say By and flip although it’s not truly a flip in the way that most real estate people use the word flip, but if you’re gonna not hold it very long at 1031 is, not in play, then it doesn’t make sense to do if you’re gonna hold a longer it is in play.
If you don’t have enough taxable income. In other words, if so sometimes I’ll be referred in by not a CPA to a client and at the face value, it seems like this person would be a great candidate for cost seg..
So let’s say the… And I’m gonna just use an example. They owned this big building and they bought it in the last five or 10 years, and they paid well over a million, 2 million, 3 million, whatever the heck it is, it’s a big number, whatever the big number it’s the… And it seems like there’s lots of stuff in there that would be eligible to take advantage of this.
It sounds good so far.
But that company manufacturers buggy whips, okay, okay, and they make the best buggy whips out there but nobody’s buying buggy whips anymore.
Okay, so they’ve got a great product, and they’ve got a great facility. And man, it looks like it should be great for cost seg but they’re not making any money in other words, they’re not paying any income tax, right? Well, if they’re not paying income tax, I’m not gonna help because my thing is reducing income taxes if they’re not paying income tax in other words, they’re losing money on their operation. This isn’t gonna help.
And I’m trying to think, I think those are the two times you typically wouldn’t end up doing them.
C: Okay, in your example of a million-dollar building, if you just took all your money and for example used the attorney example, the attorney, says, “Oh you know, I’m gonna take some of my savings, I’m gonna put it into real estate, so I gonna buy this million dollar building I’m gonna put the $200,000 down, but the income from the building is probably just paying the mortgage at this point, and the attorney income isn’t really high enough so to save, that $100,000… So to get the $100,000 and appreciation, you need to have $100,000 at least right in income correct income. Keeping in mind, in the scenario you just gave me with the attorney., that’s gonna be passive income for them. So they’re getting passive income from their building that they bought.
And my losses are considered passive losses so to use a passive loss you have to have passive income.
C: So they couldn’t even take that off their attorney money, the money they make.
J: Typically, no. Typically, no, unless they’re a real estate attorney. So the people that can use it against ordinary income as opposed to passive income, are real estate professionals. So if you are a real estate professional, and you sign your tax return, just under your name, where you do your signature if it says Real Estate prefect can use my losses against ordinary income.
Whereas if you are for that matter, the attorney – a divorce attorney – you’re a real estate agent or broker for that matter, if you’re not doing a lot with real estate transactions for your own holdings you can’t claim that and there are some reasons that you might not want that designation. Usually, I hear accountants won’t put somebody into a real estate professional category, because they’re gonna end up having to pay Social Security taxes on everything versus it not having an LLC or something, correct? So there are some reasons not to have that designation, but if they’ve gotten to the point where they can use cost sag and they meet the other requirements for that, then they probably would wanna consider that designation on their tax return.
C: So, it doesn’t matter, talking about LLCs just reminded me, if I have all my units, all my buildings and individual LLCs. Is that gonna keep me from taking advantage of this because it’s a separate legal entity. So one of my buildings takes a nice loss. Can I still apply that to the other buildings, even though they’re serially held?
J: Okay, so just to clarify, and be precise with my language. So the way that it would work is you would… Okay, let’s say you only chose let’s say, some of your buildings were only a $100 grand, you bought a long time ago, the market was different than… And you paid $100 grand each.
So those don’t make sense, but over time you’ve moved upstream and you’ve ended up buying some 3- and 5- and $800,000 buildings. So now you’ve got a smattering, but the small one you’re not gonna do, and you just to test the water, you’re only gonna do the most recent purchase and that one’s half a mill let’s say.
Okay, so you create the loss for that half a million dollar building, okay, and that’s that loss is gonna flow through to your personal return from that LLC into your personal return. So on that one, you’ve got a passive loss there, but on all those other buildings that you have, you’ve got passive income flowing into your personal return.
Okay, so the good news is the loss we create on that half million dollar building can go to reduce income tax on the passive income you have from all your other buildings. That’s even if that $500,000 building, let’s say you closed on a December 1th or December 29th of ‘19, you get to take all of the losses for the next 5, 7, and 15 years, as a loss, passive loss in ‘19. Okay, so you get to take all that depreciation and let’s say there was only a tiny bit of income that you know in building on that one building. One thought process might be… Well, I don’t even have all that. It’s not fully tenanted yet so it’s not really creating that much income for me. Why am I gonna do this now?
Well, you’ve got all those other buildings that you get to use those losses on if you want to reduce your income taxes in ‘19. Then you could say. Yeah, I’m gonna wait until ‘’20. Okay fine, you can do that too, so it’s just up to you and how you wanna do it, and your accountant.
C: Yeah, okay, good. I like all these. It’s great.
J: And usually people say, “Well why wouldn’t I do this, it is a… If it’s properly explained then people will usually say- and they have taxable income, so if it’s properly explained and they have the taxable income, it is kind of no-brainer.
Now, if I explain it to you like this, “Hey Christine., this cost seg thing, you’re gonna get the same depreciation either way. This guy, Hiatt, is not giving you any more depreciation, you’re just getting it a little bit sooner and he’s gonna charge you to do it.”
Well, that’s pretty negative. That doesn’t sound very good.
Logically, you would go…Yeah, why would I wanna do that?
But then his CPA partner across the table, he goes “Well wait a minute, but with that money that you save that Hiatt is giving you better depreciation on now Christine, you can go buy your next building sooner ’cause you don’t have to send money down to DC and you get to re-deploy that money sooner or… And the bankers don’t like to hear this, but… Or you could prepay your loan and save yourself 5% interest ’cause you’ve got a loan or you can go renovate the apartment building more quickly because now you just freed up X dollars and you can fix up units 2, 3 and 4 when you thought you were only gonna be able to fix up unit number one this year. Well, now you can fix up the other ones as well. Not having to borrow as much money.
C: And now you can increase the rents.
J: Yeah, increase the rents, make the curb appeal of the building nicer or whatever, it is. You’ve got a lot more flexibility with it
C: Money in the hand is always better.
J: Correct, but it does depend on how it’s explained to you, and I fully agree with you I think that: if you can take the deduction now, why wouldn’t you? And if I said to you, “Hey Christine. Would you rather take a deduction now or in 39 years?”
Most people would go: I’d rather take it now. I know it is pretty… But that’s kind of what the… Or they say, “Oh you won’t have any to… And then the knee-jerk for the CPAs who are not as familiar with it, they say, “Well why you’re not gonna have any depreciation later. What are you gonna do then Christine? You’re gonna have all this passive income, you’re gonna have to pay all these taxes and you won’t have any right-offs if you go with this method. That’s not the case, you’re just taking some of it sooner,
C: Who cares? 39 years from now. Let my heirs worry about it
J: Exactly a good number of us are gonna be croaked by that, so… And by the way, on that note, since you bring up that: upon death – so if generation 1 does this then generation, 1 passes on, the properties hand over to Generation 2, the depreciation clock resets, so there is no recapture at that point. Generation 1 has used the cost seg to grab the tax deferral now and then when they croak, the clock resets and generation 2 can grab the depreciation then.. So that’s kind of a big win. Except somebody had to die.
C: But that was gonna happen anyway. That’s another part of the decision-making process, right, if you think… Well, 20 years from now, I’m whatever age, so I’m 56 I’m probably, I’m thinking I’m gonna still be around in 40 years, but that might not end up being the case. And then, so it should be part of my decision making process that while I’m still young enough to invest in more properties and have more things going on that I should get all the money I can, in my hand and later on.
J: And that’s part of the deal where you gotta put generation worry about it. Yeah, but again, it’s not if that’s the scenario is you’re just saying, “Hey it’s going to the next generation, it’s nothing for them to worry about. As a matter of fact, they would likely say, hey Christine you should hurry up and do this before you croak. You got a tax benefit now and then when you croak, it resets. That’s kind of a big deal
C: That is a big deal, it is a big deal. I’m glad we kind of accidentally got into that. Yeah, any other things like that? You can think of any other huge gains for doing this that maybe we wouldn’t have thought of.
J: Well, one of the things that just happened about two or three weeks ago now, Congress fixed one thing that had expired, and they did it retroactively, for two years. What had expired was a deduction and or credit that is in place for people who make their buildings more energy efficient.
If they do energy efficiency upgrades, so if they do lighting and HVAC and building insulation, they can get $1.80 per square foot as a tax deduction. That was re-approved. It had been in place since the Energy Policy Act in “O5 and it expired 12/31 of ‘17 so now, it was just re-enacted December 20th of ‘19, retroactively to ’17 and it’s going forward to the end of 2020. So now there’s a little bit of window for planning, but at least they’ve got $1.80 per square foot as a tax deduction.
If they do energy efficiency upgrades to apartment units, it’s not that $1.80 per square foot, it’s a $2000 per housing unit – in other words, per apartment – tax credit.
So if they had five units, it would be potentially a $10,000 tax credit, which is a dollar-for-dollar offset versus the $1.80 per square foot deduction, which is a deduction against income, the tax credit is an offset.
And so that got reenacted. That’s a really nice one there. So these are all the areas that I swim in – all the swimming pools I swim in.
C: Well, any legal way that I can pay less taxes. I’m happy to hear about it. I don’t wanna be chased by the IRS, but if they’re just like, “Oh okay, well everything you do is cool.”
J: Yeah, and it’s all legal, it’s all in the tax code.
I can get a lot more. I could bore you to tears pretty quickly with some of the tax details but the big picture is what we’ve covered here. So without getting too far into the weeds with everything.
C: Well, it’s funny that’s one thing that I’ve noticed is when you talk to a really good tax accountant or somebody who does tax-related things, the really good ones are excited about all the ways that they’re saving you money, whereas a bad one is afraid that you need audited.
He’s like, “Oh come on, bring it on. We wanted to…
J: Well, and like you say, if it’s legal and it’s not gonna create a problem, why would you not wanna take advantage of it. Well, I’m glad we were able to talk here. So did you have another question or two?
C: Well, yeah, I just wanted to quickly say, “Do you have a blog or a website where people who want to get more information and stuff, how would they reach you, how would they learn about you?
J: Well, yes, the website. I’ve got a couple of different ones, the one that’s really, really specific to cost segregation is costsegstudies.com. The other one that’s a little bit more wide-reaching. Is revenuebanking.com, which is what my original domain was back in 94, and I just added tools and it’s become more focused on cost segregation but there are some other tools that I mentioned in there, on revenuebanking.com. So there’s a couple different options to get to me, but I don’t do a blog per se, and I, I’m not a social media guru.
C: So is there anything else I should have asked you, anything I forgot to mention or that is exciting in your realm that you wanna share?
J: Not so much, I mean you’ve covered a… One of the big things is you can go back retroactively.
So that’s a good thing, that’s a big exciting thing. The new tax laws really have enhanced the benefit and it’s viable for anybody that’s got $500k or more in buildings, and that’s where we work we do big, big building. So we’ve done 32-story office buildings in downtown Los and… And we do a little quick service restaurants that serve coffee and donuts so we do all kinds of different stuff, but apartments are one piece of that.
C: Well, you had mentioned also, if someone’s renting, but they do a lot of capital improvements in the case of a restaurant. I kinda glossed over that, but you wanna just quickly address that this is the same process,
J: Same process. Here’s the crazy thing: the new Tax Cuts and Jobs Act. It used to be prior to TCJA that restaurants had their own 15-year depreciable life for everything, so it could even be that there are buildings, their overall buildings, which everybody else had 39-year it could have been prior to TCJA that they would get 15-year on the building and 15-year on their improvements.
Well, that went away under TCJA, and they fell back to the way it used to be, which is 39 year for their building, and they got 5, 7, and 15 just like everybody else for the other stuff.
So restaurants – we had a restaurant chain that was told by their accounting firm that: “We’ve done everything we can, we’ve taken all the acceleration we can and you’re all set. Why are you talking to Hiatt and his guys?” And we ended up saving that client, we got them about $2 million of additional depreciation that their accounting firm had been throwing them into the wrong depreciable lives and we were able to help them go back, save them a bunch of dough and at one of their conferences, one of the big franchisees was walking around with a photo of a of the savings we had made for him, so he was a very happy person, very happy.
:C That’s the kind of advertising you want.
J: Yeah. What do they call it? Raving fans or something? That was good, that was nice.
C: Thank you very much, I appreciate this. I feel much more educated now. Thank you Jeff, for helping us to reduce our taxes legally. Tune in next week when we’ll be discussing among other things, getting started in the stock market in the meantime, have a great week.