How to Use Accelerated Depreciation to Save Thousands on Taxes

0:00As many things in life, you know, the path that wasn't a straight one. But I'm a CPA. I do I used to do tax returns for over 20 years and partnerships, Ccorporations, all kinds of stuff like that. And then I was working in a CPA firm, a large CPA firm where I was put in charge of managing their cost segregation practice, which meant I needed to learn all of the ins and outs of it. Which for me personally is is nice because I like to learn new things. Gets very boring when you do the same thing over and over.

0:31But once I landed in this space, I loved it from a personal standpoint just because I could help people and really make a difference in their lives as opposed to just filing their tax return, which is just something that you have to do. Absolutely. No, that makes sense. So I guess for people who aren't familiar or this is the first time they're hearing this term cost segregation, can you kind of explain what that means? Well, it's it's essentially so we we've kind of rebranded the name to be accelerated depreciation because so many people have told me cost segregation doesn't really mean anything.

1:06It just like words, right? So, it doesn't but really what you're doing is you're taking when you buy a piece of real estate, any type. It can be a large commercial property or a rental property, it's the same. You've paid a fair market value for that and that's one lump number. But when you go to depreciate that, that's all you have is the lump number. In reality, you are allowed to depreciate the components of it. But you don't know how much of those components, what dollar value to assign to them to be able to depreciate them more quickly.

1:40So it is allowing you really the cost segregation the accelerated is allowing you to tap into the accelerated depreciation sort of hidden in your real estate that you can't know is there or how much is there until you separate your assets and get a dollar value. Got it. Okay. So, if this cost segregation or accelerated depreciation process didn't exist, what what's the time frame that you'd be able to depreciate or write off your your rental property? 27 and a2 years.

2:1227 and a half years. Okay. So, you take the exact same amount, divide it by, you know, 27 and a2 years and and that's how much you can write off each year against your taxes. Mhm. But by doing this, like you mentioned, you could take the components that wear out quicker and front load those and get a much bigger write off up front. Got it. Okay. Exactly. And it it makes sense when you think about those components. You have to, you know, replace cabinetry or you're going to have to you're going to have to do upgrades and repairs and significant upgrades, a roof, etc. In that time period, that whole property is not going to last in its current state for 27 and a half years.

2:50Yeah. Got it. Okay. So what does the process look like of a because I think people have heard of the term before, but what all goes into the process of a cost? Essentially, you're going to reverse engineer that purchase price. So let's say you purchase something for a property for $600,000. You want to assign a dollar value to every single item, flooring, walls, doors, piping, toilets, everything until you get sprinkled down to equal $600,000.

3:25That's the first step in any cost segregation. Then once you've done that and you have a dollar value now assigned to your roof or your flooring, then you can look at all of the tax law, which is all court cases actually in this area, and say, "What does the IRS allow me to depreciate more quickly?" And then you put them into those buckets that the IRS allows. That's the whole process. Okay. So that sounds to me extremely daunting when you describe it. If I was to to just start listing all that stuff.

3:58So, how does I guess I was going to ask you later on about rental property refund because I know that's the platform that you work with and that I'm I've seen and I'm really excited about sharing with this community. How does rental property refund make that process a lot simpler and less less daunting so you don't have to look through you know precedents in in previous court cases? Well, traditionally in anything that's complicated like that you have to hire you might hire a CPA or you might hire a lawyer, you know, whoever knows that that tax law.

4:34But rental property refund has created a software that sort of embodies all of that knowledge, which is something that didn't exist before. Traditionally, you had to pay somebody to manually break out your building, your house, because there's differences between your house and the one next door. You know, you might have a hot tub or you might have x amount of square feet or you might have some special kind of shed or a nook or who knows what. So you really it was a manual process prior to this software coming out and being able to really nail down the specifics of your property perfectly and auto automatically almost automatically.

5:18Yeah. Yeah. That's what I noticed too because I've I've done some of these in the past with a CPA firm and it was really expensive. Took quite a while. And then you know going through this this platform I'm just that's why I'm super excited about it because it it just it's so much quicker and you know makes makes the whole process streamlined. So what for for people who own rental properties and they're curious about you know what what could I potentially save on my taxes? Is there sort of a rule of thumb or a ballpark of of how that typically works out on a on a rental property?

5:56Typically, you're going to be able to break out 20 to 25% of your total cost. Now, that's after you take out land. Land's not depreciable. You got to take out a chunk for land. And then the remaining depreciable piece, usually that's the portion that you're going to be able to bring into a short life. But, as an example, I mean, the best example for me is my husband and I just opened an Airbnb this past year. Now, Airbnbs are actually 39-year assets and not 27 and a half. So, you're going to stretch that again another 12 years.

6:28So, we spent we depreciated I think it was like 600,000 and we saved 25,000 on our taxes this year and 24. So, it's pretty exciting. Wow. Wow. Okay. So, so just doing rough math here, let's say we got a $500,000 property. Your basis is 500,000 of all your costs. You take out 100,000 for land, so you got 400,000 left over. So you could frontload say around $100,000. And then that basically offsets if if it's a short-term rental, you know, and you've we can talk about the requirements for this or, you know, there's I know there's scenarios for short and long-term rental.

7:12We'll talk about that, but that offsets 100,000 of your income on your your taxes. And so that's that's how that that 25,000 kind of worked out there or you know it'd be somewhere around that mark on your tax bracket. Got it. It's a time value of money concept because at the end of the day you're going to get the same amount of depreciation over the life of your asset 27 and a half years but you're not going to hold it that long. So if you can bring depreciation from those back years and pull it into year one then it's yours.

7:45Then you get to take it and then you can sell it after five years, 10 years rather than waiting 27 and a half years when that same dollar deduction is is now 30 years old and and has been chipped away with inflation. Yeah, that makes total sense. And one of the questions I get quite a bit around this this idea of depreciation is so is that that amount forgiven then you know or does it when you depreciate the asset technically you're lowering the basis and once you go to sell it then there's going to be a a higher profit margin or a higher spread between your basis and what you're you're selling it for.

8:21So potentially higher taxes then. So what are there strategies that people use to offset that then or what what can you speak to about that? That's a complicated area and there are there are strategies but in general the you know you're talking about the recapture. So what happens is if you let's talk about the five-year asset. So the items like flooring is a big one that you can put into fiveyear life. If you what you're doing is you're using accelerated depreciation there which hence the accelerated depreciation straight line depreciation is your regular 27 and a half year.

8:59So there's a there's a rate play delta there. So if you've held your asset for all of five years then you're going to only recapture it as if you did straight line if this makes sense which is only is 25% as opposed to 20% for your gain. So the delta is very small, but you've got the benefit at your ordinary income rate, which depending on where you are could be 24, 32, 37%. And if it's offsetting your W2 income because it's a short-term rental, then you're also offsetting social security and Medicare.

9:32So your benefits usually way outweigh what you're going to get back on the back end. If you want to avoid it all together, you can do a 1031 exchange if you're buying another rental property and that's going to defer it. You can also just wait until you know you you keep all these properties and you let your kids inherit them and they're going to go to them taxfree. You'll avoid it that way, too. All of it. All of the game. So, there's a couple different strategies depending on what your long-term plan is. Just think about it. Yes. Absolutely. No, I think that makes sense and I think I appreciate you sharing that because it's a it's a whole rabbit hole we could go down and there's a lot of nuance to it, but I think a lot of people are afraid of that and so they off they trade off paying high taxes because of the fear of depreciation recapture when there's strategies like a 1031 exchange or others where

10:21You can really defer taxes in a perpetuity really if if you if you want to if you're you're smart about it. One of the things that people don't understand is that you will be subject to recapture no matter what. I've met many people who just don't depreciate their properties at all because they don't want recapture. You're still required to recapture the depreciation you should have taken. So, you just really messed yourself up by doing that. You can't get out of it. Yeah, that's a great point.

10:52And I think a lot of my audience works W2 jobs, you know, and and maybe a lot of them probably have the goal of eventually living off rental property is, thus the the name of the podcast and probably why they're listening. But, you know, in the meantime, I know there's certain rules around using this accelerated depreciation to offset W2 income. Can you kind of speak to that and what's the difference between short-term and long-term rentals? Well, the main difference between the short-term and long-term is short-term is defined as on average your stay is seven days or less.

11:27So, you're really turning over your clientele frequently. So, in tax law, hotels are an active business. And so, they are considered 39-year asset. And so, that's really where you're going with your short-term rentals. Kind of taking it out of the whole rental rules that make you have to have passive income and loss. You're taking it into the active business realm. And by doing that, the first step is to have your rentals be on average seven days or less.

11:58The second thing is you need to be active in the business. So, you need to be booking people, talking to people. If you have a management company, you will not qualify. This is going to go back into the passive bucket. But if you're doing that yourself, maybe even doing the cleaning yourself, it you have to be putting in more hours than anybody else, including those cleaners. So for us, we do the cleaning. We do we do with the talking to people on the, you know, Airbnb back and forth and all that. And so that that qualifies. But here's the here's the trick with it.

12:31The first year you buy your property, you do that and it can be like in September. So you do that through December and then it's active and then you can put that on your return and then maybe next year you hire a management company because now you've taken your extra depreciation. So there's strategies around all that stuff. Yeah. No, that's that's that's really smart. And part of what I teach to to people who I I coach in this is is to manage your own properties because most property managers charge 20 to 30% for short-term rental property manager.

13:04So you can easily set up systems. We don't clean our own properties, but one strategy we have is we have multiple cleaners. So, you know, I know that as long as you have more time in it than any one other person, then it still qualifies. So, you know, we have different cleaners clean different properties and so it it allows us to offset that a little bit. So, and then how about with long-term rentals? Can can people still do this strategy? Long-term rentals are going to be passive and they are going to be but you can still do accelerated depreciation.

13:41You know, also cost segregation. You can do that as long as you have income in your passive bucket. So for taxes, you've got active income, you have passive income, and you also have portfolio income. Portfolio is like interest and dividends. Your passive is going to be largely your rental properties. So is if you have enough, you know, and you know, if it's a short-term property, even if you have a management company, you still might be making a really great revenue. If you're paying tax in that bucket, then it's definitely going to work for you. Yeah.

14:13Awesome. Awesome. And then I know that there's there's talk about the amount of depreciation that you're allowed to take each year. There was there was changes that Trump made during his first administration. Now they're they're talking about changes. What so what's the current percentage of the accelerated or bonus depreciation that you can take and what are the potential changes around that? Okay. So the first thing to to think about is that accelerated depreciation is different than bonus.

14:46They're two separate things. Okay. First, you put your money into your buckets and then those buckets get so for that five-year asset, normal depreciation, you depreciate 20% of it in year one, 40% in year two, and then it goes down. It's called double declining balance. Now, what bonus does is kind of on top of that. So, let's say we put $100,000 into that five-year bucket. Bonus says whatever you put into these short life buckets and it's not just for rental properties. Go ahead and just expense a portion of that and that's the percentage right away in year one and then remaining leftover.

15:23So let's say right now we're in a 40% bonus year. You asked that 40% of that so $40,000 boom would be expensed in year one. Then you take that remaining 60% and depreciate it over five years. So that's how that would work. So in a year where you have no bonus, you just depreciate over five years normal. In a year with a 100% bonus, you're going to just wipe out the whole balance and just take it in year one and it never had to live out its fiveyear life. So what happens is Congress uses that as a lever to stimulate the economy rent, you know, rental properties, US investment.

15:56They like that. So they will give us different bonus rates at different, you know, different years. It happens every year to try to stimulate things. Yeah, that totally makes sense. And yeah, I was kind of conflating the two of the accelerated depreciation and bonus depreciation, but that that makes sense. And so I there's a lot of talk I think that that we're going to go back from 40% up to 100%. What what's your thoughts on that? Do you feel like that's going to be that's going to happen this year?

16:28I feel like we will. I don't know if we'll go up to 100. If you look his throughout history, so bonus depreciation started in the early 2000s. Most years we've had 50. It was really just a couple years there when Trump was in office last time that we got the 100. He might bring 100% back. It depends. There's so many things that they look at up there, but I do think it's going to they're going to have to strengthen it for sure. But one of the things that you should think about if you're think if you've bought like a 25 property 2025 property and you're not sure if they're going to change the bonus rate and if it's going to be retroactive to January 1st which is what we think might happen then you still are beneficial better off to go ahead and do a study and you've got your numbers because when you're most if you're paying estimated taxes especially

17:17On your rental income then you could go ahead and offset set your next payment with what you know your benefit's going to be. And then when you after you've done the study, if the bonus rate changes, we will email everybody with new studies and with your new numbers before you file. You just have to have your number solidified before you file in 25. But it's going to help you with your planning to go ahead and do it now and even plan for your 40% because you know you've got that. Reduce your estimated tax payments by that amount.

17:50And then if the law changes, then reduce maybe your third or fourth quarter payment a little bit more. Got it. Yeah, that makes a ton of sense. I was going to ask about the timing on it. So, it's not like you have to have the cost segregation done by the end of the year. It's just prior to filing your taxes the following year. But by doing it now, you can see how much you're going to save if you have a property that that you purchase this year. Yeah, for sure. I'm a planner, so I like to know my numbers. I don't want any surprises and it's it's just good cash flow planning to not pay extra to the IRS ever.

18:25So, you don't want to be paying in based on a full amount and then at the end of the year get a refund. I mean, that's just tying up your cash. So, yeah, this is that's the best strategy.