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Tax Smart Real Estate Investors Podcast
313. Do I Need To Do A Cost Segregation Study?
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In our first monthly Q&A episode, Ryan and Thomas…
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You're now listening to the Tax Smart REI Podcast, the number one tax podcast for real estate investors.
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Your source for all things real estate, accounting and tax. Here we reveal our secrets that can save you thousands in taxes, streamline your accounting process, and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors, and current clients on what strategies they use to grow their business and how they steer clear of Uncle Sam.
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Thanks for tuning into this week's episode of the Tax Smart REI Podcast. Today we're going to be discussing questions, or taking questions rather, from our Facebook community, Tax Smart Investors. If you're not already in the community, you can join by going to Tax Smart Investors on Facebook. Just go search for it. We'll come right up. Go ahead, post your question there. We might answer it live on one of these episodes or we'll get you an answer within the community. Having said that, we're going to be diving into all these questions in just one minute. Are you ready for the 2025 tax changes under the new Administration? With new leadership in Washington, the tax landscape is shifting fast. These are some of the biggest updates we've seen in years, and if you're not proactive, you could be leaving thousands on the table. But don't stress, we've got exactly what you need. Access our exclusive 2025 tax changes resource, an in depth tracker that breaks down what's new, what's changing, and the strategies that you need to stay ahead. This isn't just some generic checklist. It's a powerful and live resource tailored for real estate investors like you. Head on over to ww.therealestatecpa.com 2025tax changes to access this essential resource, you'll get immediate insights into how to navigate the new administration's tax policies and how to keep more of your money in your pocket. That's ww.therealestatecpa.com2025 tax changes because smart investors don't just make money, they know how to keep it. We'll see you over there, but right now we'll jump right into today's episode. All right, and we're back. So what we're going to be doing is, you know, once a month we're going to be dropping a fifth episode to the show. Can you please it or not? We're going to be adding another episode and it's going to be focused on questions from our Tax Smart Investors community. We may also take questions that we get via email or other places, YouTube comments, things like that going forward. So really this is just what our investors asking currently. That's what the purpose of this episode is. So without further ado here, let's go ahead and just take the first question. Okay. If I sell a property in January 2025 and I realize a $300,000 capital gain, I'm estimating I'll owe roughly 45k in capital gains taxes. Do I immediately owe that tax or do I file it in April 2026?
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Yeah. So first couple of comments, whoever that was. So 45,000 divided by 300,000 gain. Yeah, they're doing a 15% capital gain. We're going to assume long term. If that's true in your income, that long term capital gain, you got 0%, 15% and 20, 20% is really going to be for those. I think it's like 700,000. Right? Don't quote me on that. You can go Google it or Tom, you can Google it. But yeah, we can assume 15%. Great. Assuming you've held it for more than a year, when is it due? Right. Bottom line, yes, your answer is correct. It's April. It's not due then and there it is just due when you file your tax return. Now, with that being said, just kind of wanted to directly answer that. With that being said, you are going to want to think through should you pay an estimate if there has been no withholding on that sale, which is usually not going to be right. So you might just want to consider, should I make that 45,000 payment, you know, end of the year before I file my tax? Is something that is going to be a consideration. We would definitely recommend that just to kind of make sure you reduce any sort of issues with penalties, interest, because you've got a huge tax bill due. So we do recommend making a payment sometime earlier in the year before you file.
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Perfect, perfect. The next question we have, this is a good one. How do we use a partial asset disposition? I removed a roof on my property, got it replaced, and now my question is how do I know the value of the original roof for the purpose of a partial asset disposition? So just quick, you know, overview of a partial asset disposition for everybody who may not be aware what that is. So when you buy a property, you're going to depreciate that property if it's residential, for example, over 27 and a half years and all of the components of the property start depreciating. Now that roof, right, the roof is the component that's depreciation over twice and a half years. Now say you replace that roof. When you replace that roof, you're adding that new roof to your depreciation schedule and then you're going to depreciate that roof over 27 and a half years. Okay, but what happens to the old roof? Well, the old roof is still on your depreciation schedule in many cases. So now you're depreciating two roofs over 27 and a half years. What the partial asset disposition allows you to do is deduct the remaining cost of the original roof and in the year that you replaced it, say the remaining value of your old roof was 20k. Just making this up here, right? Well, instead of having to depreciate that $20,000 over the rest of the life of the property of the 27/2 years, you just immediately deducted in that year. All right? So that's more beneficial for you because you're getting a big deduction in that year. So to answer the question though, how do you find out the value of that roof? The primary way of doing it, the most common way, is by having a cost segregation study performed on the property and they're going to give you the breakdown of the value of all the components within that property so that maybe if you have future replacements and you need to do future partial asset dispositions, you already have those values. Obviously, we know the primary reason for a cost seg is for to break down components for bonus depreciation. But partial assets dispositions is another way. That's the first way to find out the value of the roof is by a cost segregation study. The second way is by using the producer's price index and basically indexing back the value of the roof. It's a little bit more complex. We're not going to go into all the details of how that works here on today's show, but that is another way to do it with again, cost seg being the most common and probably preferred way to do it. Okay, next question. Income generated by flipping a property would be active even if you're not a real estate pro and have a full time W2 job. Correct?
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Correct. Correct. That's the short answer. Yeah, we're not talking about rental property. And is it active versus passive? Yeah, by default, flipping isn't necessarily passive like rental properties are. So yeah, I'm going to assume that you don't just invest some capital into an already, you know, ongoing flipping business. It is going to be non passive. I know they use the word active. There is technically a difference there. I'll just comment on between active and non passive. But yes, that would be non passive.
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All right, here's another good one. It's about the real estate professional status. Can you please clarify if qualifying for the real estate professional status by meeting all the tests and I materially participate, would you still have the 150k loss limitations or not? Short answer to that question is no. When you qualify for real estate professional status, you are not subject to the $150,000 limit, which is also known as a special loss allowance. So for everybody who may not know what special loss allowance is, if you make less than a hundred thousand dollars, so it's modified adjusted gross income or MAGI, then you can get a deduction up to $25,000 in your rental losses. Right? So you can just take those, those are non passive. This deduction is phased out $1 for every $2 of income above 100,000 until you hit 150 where it's completely phased out. Okay. This has never been indexed for inflation. We talked about that in a prior episode. It'd be significantly higher and more favorable if it had been. In fact, many people would not need the real estate professional status. But it has never been indexed. So this is what the real estate professional status, this is where it comes in handy, right? Real estate professional status makes your rental loss is non passive and it gets you around this. So the special loss allowance is no longer applicable. You could take losses even if you're making more than 150,000. Okay. That is the benefit of the real estate professional status. Next question. Do I have to do a cost seg study during my first year of ownership?
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The short answer is no. There's a form, form 3115, 3115 that you can use if you, for example, placed a property in service in 2023, but you would like to do a cost segregation study on your 2024 tax return, for example. Right. So different year when you place it in service compared to the year that you want to take the cost segregation study. So you use that form because basically what you're telling the IRS is that you, you started doing depreciation in 2023 in my example, a specific way. Here's how I calculated it in that first year. But hey, irs, I got some new calculation and method for how I'm calculating my depreciation on this property. And therefore I'm including this form along with some attachments and some kind of explanation of how you're coming to that. Using Form 3115 to kind of show how you're, you're coming to that. And then that, yes, will be an expense. Any sort of acceleration you can get for that rents property. But bottom line is no, you don't have to do it in the same year. You would just use Form 3115.
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Absolutely. There was actually a follow up question to that. One is how many times can you use a cost segregation study on the same property? The answer to the question is you could theoretically do a cost segregation study as many times as you wanted to on one property. However, it wouldn't be very beneficial to you. Most of the time you're doing a cost segregation study usually around the time you buy a property. Usually. Okay. Or it could be in subsequent years if you didn't. But you're doing it one time to break down those components so that you could depreciate them faster. Right. Once you do that, there's usually limited benefit to doing another cost segregation study. There's not many cases. To answer your question, you would typically only do one.
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And just to highlight that too, because I think the people thinking through do I do it multiple times might be thinking, hey, I've done some improvements to the property that I need to capitalize. Okay, fine, yeah, go do an improvement study. Hey, I spent 50 grand on renovations. Okay, how much of that is 27.5 verse 15 versus 5. Great, go do like a study on that. But you're not going to do. If you bought a property for 500 grand, that's what your purchase price was. You're not going to do a cost seg every single year on that save 500 grand cost that you have. It's just going to be basically like one and done for everyone. So.
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So next question, when is, and this is going to be a good one. When is 100 bonus depreciation coming back? All right, we're actually going to have Nathan Sosa, national tax manager here at our firm join us in the coming weeks to give us a full debrief of what's currently going on in the world of 2025 tax changes. So stay tuned for that episode. We'll have more information. But right now the answer is we expect it to be in 2025 at some point this year. But there's relatively little information on specifics in terms of timing. Will it be 100%? Will it be something else? But here's what we do know, and we've covered this before, but here's what we do know so far. We know that there's bipartisan support for 100% bonus depreciation in 2024, the House did pass a bill that included extending 100% bonus depreciation so well as bringing it back to 2024. Right. We're not going to probably see that happen retroactively to 2024 at this point, but between the bipartisan support for 100% bonus depreciation and the current administration support for 100% bonus depreciation, it is believed to come back at some point during the reconciliation process, which will either take place over one or two bills. Right. Initially with the first initial reports of this was that they wanted to get it done within the first hundred days and as part of one reconciliation bill would include the tax changes. That is evolved into a conversation of there might need to be two reconciliation bills due to the amount of things that they're adding into these bills and the taxes would come in the second reconciliation bill at some point later on this year. That's kind of where we're at right now. We'll have to wait and see. Again. Nathan Sosa might have more information for us in a few weeks. You'll have to wait and see, but that's kind of what we know as of today. Again, we're all rooting for 100% bonus depreciation to come back. And I do expect it to come back. But we'll just again, it's not over until there's a bill signed to law and we're sitting here celebrating 100% bonus depreciation. So to answer your question, maybe in 2025, we'll have to wait and see. With 2024 officially in the rearview mirror, now is the perfect time to start planning for how you're going to maximize your tax savings in 2025. With major tax changes looming under the new administration and IRS audits on the rise, navigating the tax code alone is now riskier than ever. Whether you're leveraging the short term rental loophole, claiming the real estate professional status, utilizing passive losses, 1031 exchanges or anything in between, our expert team of tax advisors at Hall CPA has your back. We'll help you uncover hidden opportunities and avoid costly mistakes that could put you at risk during an audit. With potentially tens of thousands of dollars of tax savings on the line, why wait? Visit ww.therealestatecpa.com podcast to request your free 30 minute discovery call today. Again, that's ww.therealestatecpa.com podcast for a free consultation. Let's help you ensure you keep more of what you earn in 2025. That's all for now and we'll dive right back into today's episode. Here's another good one. Do I need the real estate professional status to use the short term rental loophole? Okay, you want to take that one?
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Yeah, I would love to take that one. Go for it anytime. The phrases real estate professional status and the short term rental loophole are in the same sentence usually. I know that there's some confusion of kind of what's going on there. So first thing I'll comment on, think of, I don't know, we're accountants, so we think kind of, you know, T bars or T accounts or whatever. Debits credits, maybe that's a better phrase. You've got basically long term rentals on one side and you've got short term rentals on the other side. Okay. As you think about long term rentals, you are thinking, I want to claim real estate professional status. As you think about short term rental properties you own, you are thinking, I want to claim the short term rental loophole. Is there a overlap here of real estate professional status can help me meet or help me use short term rentals over here in this section to make them non passive? No. So basically real estate professional status is just for long term rentals. Short term rental strategy is just for short term rentals. It's kind of in the name, but. But for some reason there's kind of this mix between the two. But bottom line is that it comes down to the short term rental loophole. Exception basically is saying, hey, if you have an average stay per guest of less than seven days on average, that is basically not a rental. So that's basically outside of the whole. Real estate professional status is turning rental properties into making them non passive. Right. That kind of basically takes them out if you've got that average day less than seven. So it's no longer under reps and now it's under its own completely different thing. How do you make comments there, Tom, as far as, like, do you need that?
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I don't think so. I mean, the only thing I could add is that, you know, you don't need it. Right. Like Ryan said. And one of the benefits of using the short term rental strategy loophole, whatever, is that you don't need reps. And that's why it's so popular these days. And as you know, we had John Bianchi on, you know, a few episodes back discussing, you know, how to actually profitably invest in short term rentals. Like, again, it's a business. I'm gonna have to disclaim this here. It's a business, it's an operation. It's something you have to have ongoing attention to, to do effectively. But that's one of the benefits of the short term rental strategy. So we're gonna take a few more questions here today. Again, if you guys have questions, if you're listening to this, you're tuning in right now, go ahead and join the Facebook group at Tax Warren Investors. It's just go search Facebook tax1investors. You'll be able to see it. Or you can just go to facebook.com group taxpoint investors and you could go ahead, drop your questions in there and either somebody's going to answer in the community or we're going to go ahead and we'll eventually answer and then maybe the next episode. So here's a good one. I'm closing on my first short term rental early this year and we'll need to put some work into it before it could be rented. Will the cost of paint and other minor repairs be a business expense, maybe a startup expense or qualifying living in a safe harbor prior to the property being placed in service?
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Yeah. So in general, if anything's before it's placed in service, we generally think it's going to be capitalized. That's like the, the broad brush stroke comment to say so paint specifically, because it's that physical property, generally it is going to be capitalized. And we're generally not going to be using the de minimis safe harbor. But do keep in mind, for paint specifically, we're also considering the routine maintenance safe harbor. Sometimes you expect to do that two times in a ten year period. But again, in general we're going to capitalize it because I'm assuming it's before the property is placed in service. So with that, a brief strategy would be to consider if the paint for right now is good enough. Could you have a few stays and then maybe in the off season get it repainted. Great. That is something that some people do. And now we can for sure start to evaluate things like the minimum safe harbor or the routine maintenance safe harbor specifically for paint. Now I just want to mention one last thing. What we commonly say is again, costs before it's placed in service are going to be capitalized. The only potential nuance there is if you have something that's called consumables. Okay, so consumables would be like toilet paper, paper towels, soap, sponges, things like that, where it's like kind of a one time use that those could yes, be expensed even before it's placed in service. Okay. Just kind of keep those nuances in mind because it's not something that's going to stick around really. It's literally just a one time use and throw it away. So that would be like one good example of like what could be expensed before it's placed in service. Consumables. But yeah, in general. The short answer, again, just to recap. Yeah, generally not. And we're going to be capitalizing that.
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Awesome. Awesome.
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I'll take one Tom that I see here. So basically this one says my husband received 1.25 million for W2 income. W2 job. They did a cost segregation study for 688,000 of depreciation for that first year. Does this mean that they only pay the 562 of income in 2024?
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Yeah, that's a great question. So this kind of just. We always get this question too on depreciation. So depreciation is an expense and this includes bonus depreciation is an expense on your profit and loss statement. So you're going to have rental income. Okay. You're going to have all your other expenses, takes to operate your property, property management fees, repairs, maintenance, all that good stuff. Then you're going to have depreciation. That depreciation is likely going to cause a loss. So if we just assume for the sake of just keeping things really simple that depreciation was your only expense, then that loss that's created by that depreciation will offset your W2 income, reducing the amount that you're going to pay taxes on. Now there's something important to note here. With depreciation expense or losses that are rather losses as a result of depreciation that are that high. Right. The number was like 500 and something thousand. Ryan, you mentioned 688. 688,000. That's tremendous. Must have been a pretty big property. There's something called the excess business loss limitations and the excess business loss limitations allow you. And so we're going to look at 2025 for these allow you to deduct up to $626,000 of losses against non business income for the year. Right. Once you get above 626,000, the rest gets carried forward as a net operating loss.
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So.
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So in this case you'd be limited to 626,000. That's the most that's going to be able to offset your W2 income. But it's still very significant. If you're at the 37% tax bracket, I mean, which it sounds like you're going to be in for the most part, that $626,000 at the federal level is going to save you 231,620 bucks. That's a lot of money. It's a lot. Right. So that's still significant. So it may not offset all of it, but it looks like it's going to offset a significant portion of that loss. You're going to be able to use a significant portion of it.
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Yep. And Tom is also assuming that you made something like real estate professional status or the short term rental strategy. That wasn't explicitly mentioned in the comment. But we're assuming that that loss is non passive by some means. Right, right. Because you've got the W2 and just a comment to Tom was assuming married filing joint. The question said my husband. So again we're kind of assuming married filing joint.
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Those are good clarifications.
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Yeah, but absolutely. And it does carry forward, like we said, any excess above. So that 626 for 2025 compared to the 688. That difference there of about 60 grand or so carries forward as an NOL into 2026. You don't lose it. You just don't get it right now in this year. A little bit of a bummer, but you don't lose it forever.
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Yeah, no, it's still super powerful. I mean if you're able to save $230,000 or in excess of that, that's powerful. And again this is one of the many reasons to invest in real estate is the ability to offset non passive income. And we've talked about here on the show, just one thing I wanted to say is that this is not the only reason. Okay. While this is powerful and motivating tool, there are just investing in rental real estate because think about this. This taxpayer also did not pay any tax on the rental income that they generated too, which is also powerful. So there's a lot of things related to that. Maybe we'll cover that again in another episode. But that's gonna be all the questions for today. If you do have questions again, join the Facebook group. Drop them in there. We will either be answering in the Facebook group or perhaps maybe it'll be in the next episode here where we do a Q and A. Last thing before we go. We are accepting clients. If you are looking for a new CPA firm to help you strategize on how you can actually reduce your taxes not just file your tax returns. Of course, we could help you with that too. But if you're looking for someone to help you strategize, we're here to help. We'd love to learn more about your situation. How we can help we're still in the early innings here in 2025. It's the price perfect time to get started. You can go ahead and request initial consultation by visiting ww therealestatecpa.com podcast that's it for today's episode. We'll catch you in the next episode of the Tax Smart REI Podcast.
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Thanks for listening to today's show. If you enjoyed the show, please find us on itunes and leave us a review. You can also email us at. Contact therealestatecpa.com with any feedback or topic suggestions. We are always taking on new clients and with the new tax laws in play, you really don't want to navigate this alone. Let us help you save money on taxes with your accounting and CFO needs to become a client. Navigate to our client page@therealestatecpa.com and fill out a web form with as much detail about your situation as possible. Thanks so much for listening. Have a great rest of your week.