The more ways to depreciate, the better. In this episode, we take a deep dive into one strategy that will help offset your income tax from rental properties: cost segregation. Chris Larsen sits down with Yonah Weiss, a powerhouse with property owners’ tax savings and the Business Director at Madison SPECS, to help us understand what this means and how we can apply it. Plus, he also explains when cost segregation makes and does not make sense according to the type of properties you have. Chris and Yonah then take a closer look into multifamily and share a couple of advice that would be helpful in every real estate investor’s journey.

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Cost Segregation With Yonah Weiss

On our show, I’m excited to have Yonah Weiss. Yonah is a powerhouse with property owners’ tax savings. As Business Director at Madison SPECS and national cost segregation leader, he has assisted clients in saving tens of millions of dollars on taxes through cost segregation. He has a background in teaching and a passion for real estate and helping others. He is an investor himself. He is also the host of a new podcast, Weiss Advice. Yonah, welcome to the show.

Thank you, Chris. It is a pleasure to be here joining you on the show. I love that name and I love the concept.

Likewise, you provide so much value to not only your clients but also your audience on your show. I’m excited to hear more about that when we talk about it. Are you coming to us from Asheville as well?

That’s right. I’ve been a guest on close to 150 shows. I’ll try to make you feel a little more at home.

I know you’re going back and forth between the Biltmore Estate and Downtown Asheville. This is a beautiful time here in October 2020 in Asheville. For those in the audience that don’t know much about you, tell us where you’re based and how you came to be an expert in cost segregation.

A lot of people don’t know this because I work for the largest national cost segregation company based out of Lakewood, New Jersey, but I work remotely. I live in Israel, in Jerusalem. I have been here for many years. It’s a beautiful place. I’m living the dream. Everyone in this time being hit with this work from home, work remotely, “How do I do it?” I have been doing this for years. It’s incredible that I have that opportunity to live wherever you want and work wherever you want. What we’re doing nowadays, thank God, I have an incredible team on the ground in the US, a big national footprint said to be the largest national company. What I do is having fun on social media. You can do in podcasts and that kind of stuff.

It’s more interface, phone, telephone and emails. It can be done from anywhere. That’s the beauty of it. I didn’t start in cost segregation like a dream of mine like, “When I grow up, I want to be a cost segregation expert,” type of thing. I followed my passions. I never wanted a career of any kind. I just love to do and live. For me, living is like teaching. That’s part of life is how you teach. I was a teacher for many years. I enjoyed it. I have a big family with six kids. For me, it is a daily thing. You’re teaching your kids besides helping them with homework and stuff like that. It’s how you are and you’re a role model.

I love that aspect of it, but at a certain point, the salary does not foot the bill. I was looking for something that would help me take it to the next level and take my income to the next level. Real estate came up as one of those sure-fire paths in the long run. I started out doing a bunch of different things from fix and flips and some brokerage and some commercial mortgages to hard money. I was doing all of that. I was learning the tricks of the trade and apprenticing from people that I knew that had been in the industry for many years. I was hanging out with them, doing what they’ve been doing, following them and working with them.

With that, I learned a tremendous amount over a short period of time. I networked with incredible people, which led me to where I am which was connecting with this company, Madison SPECS, which they’re doing incredible things in the commercial real estate industry, specifically in cost segregation. That’s how I got into it. I don’t have a background in accounting. I don’t have a background in engineering, which is what the cost seg is all about. However, our company has those team members who have been doing it for decades, and I learned from them. I took my teaching expertise and took a spin on it and learned whatever there is to learn and continue to learn everything there is to learn about the subject and get over like any good teacher is. I’m grateful and blessed to have that team behind me. They’re the real experts that I can play one on TV.

That’s what’s great about real estate. I raised bicycles for many years. There are all these different areas of cycling. There’s road cycling, mountain biking, downhill and track. You can have people built like football players. You can have people that have bellies that are tremendous downhillers. You then got these guys that are racing the Tour de France that are 135 pounds with 4% body fat. Real estate to me is very similar. You have all these different types of real estate. You can swing a hammer and do well at it. You can crunch numbers and do well at it. I was listening to your story on one of your episodes about how you learned a lot from BiggerPockets and was able to do your first deal from listening from them. It’s tremendous to hear where you’ve come from. Some people may be learning cost segregation or cost segregation analysis for the first time. For those that haven’t heard it before, can you talk about what it is and why you would want to do it? How do you help your clients apply it?

It’s pretty straightforward. It is a weird name, I will admit that, but it has to do with depreciation, tax deductions for real estate. Essentially, it’s an advanced form of depreciation. If you own a commercial building, any property, investment property, business property, as long as it’s not your personal residence, you are allowed to take what’s called a depreciation tax deduction, which we love. It helps to offset our income tax from rental properties. What that means is buy a building, the IRS is incentivizing you and saying, “Things go down in value as time goes on. Therefore, you can take this deduction as if your building value is depreciating.” Now, you can take a loss because you’re going to be losing money, which is not true. It’s hypothetical because your building is probably going up as time is going on. That’s what depreciation is.

You take your property and you divide that by 27.5 years. If it’s a commercial building, it is for 39 years. That will determine what your depreciation deduction from your income tax is every single year. In a nutshell, depreciation is a great thing. However, oftentimes it is not enough to cover the entire cashflow or income that you have from many properties. The IRS came up with this cool system which allows you to depreciate different assets in your building, different components of your building at faster rates. Instead of lump everything together over a 39 or 27-year period, and saving a little bit every year for that period of time, you can by identifying what those things are from an engineering perspective, identifying all the personal property stuff in the building that depreciates on a fast level at a 5, 7, or 15-year scale. You can now take those tax deductions at that faster rate. That’s what the cost segregation is. It’s a tax/engineering strategy that allows you to take accelerated depreciation or bigger depreciation upfront.

Being a finance guy, I heard about this for the first time and I made some phone calls. I had a single-family portfolio. I was like, “Can you help me do this? Let’s take some additional depreciation because I was getting hit with some big tax burdens.” This was years ago. To recap here, I talk about depreciation in my book. You can pick up a copy and read a little bit more about it. It’s a paper loss. If you’re making $10,000 a year from a property and you have a $275,000 residential building and you’re depreciating over 27.5 years, you can offset that entire $10,000 typically with that depreciation loss.

Your building is making money. It’s appreciating. I have investors call me and they’re like, “I don’t understand. I have my K-1. I’m getting my tax summary at the end of the year and I lost money, Chris. Do you have money in your bank account?” I said, “Yes. That’s what you give to the IRS.” It shows them that it’s gone down. Going back here, I have these single-family properties and I call a cost segregation company and talked to them. They said it doesn’t make sense for you to do cost segregation in a single-family house. Explain why would you not do it if you own a rental house versus why would you do it if you have a 100 or 200-unit apartment building?

I’ll touch on that in a second because it has to do a lot with the actual value and the percentages. What amazes me the most about your question is that most people that I know that own single-families have no idea what cost segregation is for this reason, which is incredible. A lot of people start out that way. You started in real estate in single-families, especially people from BiggerPockets. They started on residential, small and they’re never taught about segregation. Partially, it is because it may not apply as that person told you. Regardless, it’s good to get cost segregation. If you’re someone reading this and you’re like, “It’s not going to apply to me. I don’t care anyway,” you need to understand it. You need to know what it is so that when it does apply, you can take advantage of it. Why is it not necessarily advantageous for single-families? It is because your depreciation deduction is based on your purchase price. Let’s say you bought a single-family for $100,000. Divide that by 27.5 years, but you have to take off a certain amount for land first. Whatever is the leftover, divide that by 27.5 years.

If you buy a property, you do not depreciate the land. You separate the land. You then apply this to the actual building structure itself.

The first thing you have to do is apply a certain value to the land, which does not depreciate. Whatever’s left, that’s what we’re basing our depreciation deduction on. That $100,000 property might get you a $3,000 tax deduction every single year. With the accelerated depreciation, oftentimes it’s around 20% of that basis that you can take in the first five years in extra depreciation. If you have over $3,000 deduction, that’s great. In the first five years, you could take 20% of that $100,000 in extra. That is $20,000 over a five-year period. That’s an extra $4,000. You’re doubling your depreciation deduction. The cost of the study itself to get it done is usually cost-prohibitive to matching those tax savings.

It may cost a couple of thousand dollars to get it done on a property minimally. Whereas your tax benefit, we’re getting these deductions, but it’s not a refund check. What you’re doing with those deductions is you’re lowering your taxable liability, offsetting what’s the net value of that is going to be less than the actual deductions themselves. If you have a $100,000 property, you can apply this. Your net savings might be, in that example, $5,000 or $10,000 to pay a couple $2,000 to $3,000 to get a net savings of $5,000. It doesn’t make sense. The math doesn’t add up.

At what scale does it typically make sense? What are you seeing?

Just 10X that. If you have a $1 million property, you’re looking at a minimum of $50,000 to $100,000 net tax benefit. You have to pay the same fee, a few thousand dollars to get that done, that makes a lot of sense. You can scale that back and say, “I have a $500,000 building.” This is not only the unit count. I spoke to a guy and he’s like, “We’ve got a bunch of single-families in LA. They all cost $1 million minimum each.” It doesn’t depend on the actual unit count. It depends more on the purchase price.

You said you can accelerate this and that’s what we’re doing here in 5, 7, 15-year buckets. What are some examples of stuff that falls into those buckets?

There are two main categories in 5-year and 15-year buckets. Five-year property is personal property. It’s anything that is inside of the building that’s not part of the structural components. We’re separating out from the main structure like the roof, doors, windows, walls, floor, all that infrastructure appreciates on a 27.5-year schedule. Everything else, we’re accelerating and segregating. We’re pulling out, reallocating stuff like personal property. It can include furniture, equipment, appliances, countertops, cabinets, wall coverings, carpeting, vinyl flooring. Even though it’s attached, it’s not permanent and it’s not structural. All that stuff and all the value of those things depreciate on a five-year schedule.

There are certain ways to affix certain things, so make sure that you can apply these so they’re not part of the structure, which is I learned more about this. That’s where you guys come in to figure out how to optimize this. Correct me if I’m wrong, but multifamily to me seems like one of the best areas to do this. If you took a warehouse, for instance, it is going to be a commercial property, depreciate over 39 years. Probably not a lot of stuff inside the warehouse that you can accelerate versus a 200-unit multifamily property, with lots of washers and dryers, dishwashers, cabinets, flooring and carpeting. It’s a lot. That’s advantageous. That’s why in my book, I talk about multifamily being the Holy Grail. That’s one of the reasons. What about stuff like landscaping? Would that qualify? 

I’m glad you brought that up. Landscaping is the second main category in the bucket that gets accelerated through depreciation, which is on a fifteen-year schedule. Not just landscaping, any outside the building that’s considered land improvements. That would include landscaping, fencing, pavement and concrete. If you have a parking lot or a driveway, any of that stuff, the value of that concrete, you can take that as accelerated depreciation. Also storm drain, swimming pool, playground equipment, all that stuff, anything that has value to it. The engineer comes and identifies how much of that is in there, what’s the square footage and what’s the value applied to that. Making those calculations gets you those tax deductions at a faster rate.

I’m a nerd but that’s super cool. You can break all that out. You guys have a team that comes in and does this. You have engineers and accountants. Who were the main characters that are working on the team and what do they do when they come into a property? Walk us through a day in the life of your team when they jump onto the property that we’re acquiring in Raleigh, North Carolina for instance?

The first thing we do is we always send an estimate. Our engineers run the numbers, but even before you acquire the property, based on some data without going to the property. We’ll schedule an engineer to either come to the site physically and because of the situation, we’ve moved into virtual space. We’re doing a lot of virtual site tours, even though we have a full team of engineers. They were traveling the country throughout this station in different locations, but this is cut down travel time. A lot of what we’re doing is virtual site tours with them. They come and do measurements, pictures and taking a video of everything in the building. Once they gather all that data, they come back, take an accounting of all of that, and then make the calculations and apply them.

We have the accountants’ review. We have an all operations team that helps with making sure it’s all streamlined and through the process, and reviewing everything at least four times. That’s pretty much it. It’s a straightforward process. We are doing a lot behind the scenes but as an owner, they are scheduling someone to come, providing a little bit of information about the property, walking them through if they need, and then sitting back and waiting for that report to come back in a few weeks. That report that we create is about 80, 90, 100 pages long and very detailed, but it has one page depreciate schedule and that’s all you need. Going forward, you take that and apply that to your taxes.

It’s super powerful in getting and drilling down into that. One thing I noticed as an investor, I got my 2018 K-1s, I see this depreciation in 2019. I noticed that the appreciation seemed higher and we had the Tax Cuts and Jobs Act and Recovery Act that passed at the end of 2017. How did that change the depreciation that we’re seeing?

That was huge. What it did is it introduced something 100% bonus depreciation.

Anything that’s 100% bonus can’t be bad.

We all love bonuses. It allows you to have the option. Once you’ve done a cost segregation study, you have identified all that property, and all those assets that depreciate faster, you can take all of it upfront in that year and 100% of that as a tax deduction. We had discussed a 20% re-allocation, sometimes up to 30%. Other types of properties could be even more. Think about that, if you would want a $1 million property, you can take per million dollars approximately $200,000 or 20% of that as a first tax write off. It’s ridiculous. It’s crazy. That’s why your K-1s came back with huge losses.

These are paper losses to clarify. I was a little bit stunned and a bit happy when I saw that. People talk about Donald Trump not paying much in taxes. If you’re not like Donald Trump, what happens? You get all these years of losses, you roll those over the following year. Is that how that works?