I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
How to Waste a Cost Segregation Study
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Basis is expensive. So one of the ways to reduce that expense is to use that basis to reduce your income tax drag on other income. And for those that invest in or own real estate, you can accelerate the tax benefits of a lot of smaller components of that basis using a cost segregation study. But the cost seg is just one part of a larger strategy to actually be able to use that benefit to it's fullest potential. 👈 Today, we're jamming on a few of the ways I've seen people get disappointed in the actual effect of a cost seg study on their tax return. Syndication StrategyWhen raising money from investors to buy real estate, a critical decision up front should be who will get the depreciation. This should be disclosed and understood from the jump to avoid confusion down the road on K-1s. 🥴 Many investors are depreciation-agnostic - investing in real estate for the diversification and returns skilled private developers and / or GPs can achieve. Some investors, however, prefer all the depreciation they can get - for example if they have a lot of passive income they can use those losses against. In either case, the GP should be strategic on when the cost segregation study should be implemented. Bonusing assets early on before capital is returns versus later when debt recourse is removed can have major impacts to the K-1s (who gets the depreciation). Timing is everything when it comes to depreciation in syndications. Missing AggregationA few times a year, I'll get an email or talk to a prospect who tells me their current CPA says I'm dead wrong on how to use a cost seg for a separate LLC real estate entity the prospects main business works out of. 😡 It's common to have the property in one LLC and the business in another for legal protection. But it can cause tax issues for someone trying to plan. The common objections are the self-rental and passive loss rules. Both of which get overruled by making a specific election (1.469-4(d)1) at the taxpayer level. This election allows a few exceptions to the rule and frees up basis trapped in an otherwise passive activity to offset active business income. If you're following along between weeks, we used this election just this year for a CPA firm client and saved them several hundreds of thousands in tax. 💪 Owning Real Estate Inside a S-CorpJust don't do it. The biggest reason to not own rental real estate inside a S-Corp is the limitation of debt basis. If you're using debt to buy a building that you will rent out, and you want to use that bonus depreciation, the S-Corp will not give you (the owner) basis for the debt - even if you guarantee it. That means any losses generated - if they are financed by the debt - will not be available to offset your other income outside of that entity. Not Being a Real Estate ProI can't tell you how many times I've talked to a client who earns a lot of money at a W2 job and sends me a K1 from a real estate project he invested in - excited to see how much the year 1 bonus depreciation he got allocated will save him. It sucks explaining that the loss will stay suspended until he has passive income to offset it, or the property sells. 🥺 The same thing happens when that same W2 person buys a rental home and expects the same bonus depreciation benefit. If you're not a real estate professional, those losses from the rental cannot offset your other income (W2). It's not just W2 employees that do this - a lot of business owners who don't work in real estate seek out the tax benefits from real estate. But if the primary business the entrepreneur is in isn't real estate related, those losses stay suspended as well. The TakeawayAs a taxpayer, you gotta know who you are to the IRS - employee, business owner, real estate pro. Those categories drive a lot of strategy conversations we have with clients. And they drive whether or not your cost seg study is actually usable. This is also a good reason for your cost seg company and CPA to work closely together to model the actual impacts of those studies on your tax bill. 🫡 Group Chat Worthy Posts 🔥📲
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
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