Closed On A Small Multi This Year- Should I Do a Cost Seg?

Question

Hey Guys!

So I bought a 3 family in Feb. this year for $550k. I just refied and it appraised for $650k (Def. got a deal on it... it was off market!). It is still below market rents, but we are working up the cash flow!

So after hearing the Tom Wheelwright episode about Bonus Depreciation and Cost Segregation, my wheels were spinning. He made it seem like as long as the property was over $100k, it was worth. So I am thinking at $550k it def. should be! But the bonus depreciation is on contents and land improvements (fences, ect.?). Its a decent three family, and I own all of the appliances, but I don't see that adding up to a large amount (maybe I am wrong!).

Would love anyone's input on on the benefit in my situation. I also own LTR single family, another 3 family that I was added to deed with mother inlaw this year and taking her off this year to just my name. I am a W-2 employee Mortgage Broker on track to make $130k this year (incase this adds any color to my situation!).

Also if it makes sense to do, who do I use for a Cost Seg. in South Shore of Mass.?

Thanks in advance!

Best,

George

Yonah Weiss · Answer

@George Post you are in a boat with a lot of people after hearing that podcast. Cost Seg could be a great advantage for many people, but as he mentioned in the podcast, unless you or your spouse qualify as real estate professional status (REPS), you will be limited to use the depreciation from cost seg to offset your rental (passive) income. Unfortunately a mortgage broker is not considered a REP.Most cost seg companies will provide an upfront feasibility analysis/estimate, so you can see if the numbers make sense for your situation. BTW we work in all 50 states.

Michael Plaks · Answer

@George PostYour gut feeling is correct. With a $130k W2 as a mortgage broker and multiple financed properties, you probably will NOT benefit from cost segregation. As is, you should be able to show enough tax losses up to the limit. All additional losses, including losses from cost segregation, will only increase your reserve of losses for future use.Once you run into a situation where you need additional losses, then you might consider cost segregation as a tax mitigation strategy.This was a very generic advice, and it can be completely wrong for YOU. The only reliable way is to get your specific situation evaluated by your own accountant experienced in real estate and cost segregation. A feasibility analysis offered by cost segregation companies is a useful tool, as long as you remember that it is also generic and may or may not apply to you.

Julio Gonzalez · Answer

@George Post Your property definitely has the potential to benefit from a cost segregation study. Determining whether to do a cost segregation study or not has a lot variables. What was the purchase price of your property? Will the documentation provided from the study hold up in an audit? Have you obtained any detailed cost/benefit analysis quote? Most cost segregation study companies provide the quote for free. If you need one, let me know and I'm more than happy to pull one together for you. Some other factors to consider - How long are you planning to hold this property? If less than two years, cost seg probably isn't a good route. Are you planning to do any renovations? If so, I always recommend getting the study done prior to rehabbing. Are you in an area where land is very valuable leaving you with less to depreciate? If you paid ~$2k+ to get the cost seg study done, what is your ROI on that $2k? Do you have a current need for that cash flow generated from the tax savings? Could you go reinvest it in another property to build even more income? Would you have net income or net loss without the cost seg study? Are your real estate investments active or passive? Are your losses locked up against your passive income? There are a lot of factors to consider when get a cost seg study to determine if the benefits outweigh the costs. If your wife can get REPS status, that would benefit you tremendously. If you need any help or have any questions, feel free to reach out!

Kory Reynolds · Answer

@George Post If your wife can reasonably account for her hours to reach the REPS requirements, I don't see why not. Make sure you are counting only valid hours she puts in - there are some buckets like reviewing financials, looking for new properties, education / research that would not qualify towards the 750 hour requirement. Looking at the number of rentals you have, assuming they are fairly standard as far as required work, having 3 buildings for a total of 7 units it seems unlikely to me that she would be spending about 15 hours a week on average managing these properties. I agree that based on the surface information you are providing, it doesn't make much sense to do a cost seg right now. Cost seg studies are all about the time benefit of money - you pay some extra now, to save some tax sooner rather than later. In your case, assuming they are already showing operating losses (you noted you do have loss carryforwards), the cost of the study would provide no immediate tax benefit. If there is a situation in the future where the losses would be helpful - say one of the properties has significant rent increases and starts producing some substantial taxable income, or you sell a property at a gain, - then no reason you can't implement a cost segregation study on one of the originally acquired buildings in that later year.

Bonnie Griffin Kaake · Answer

@George Post It is in your best interests to get cost segregation pre-analyses/estimates on all your properties. Yes, even if you are not a RE professional and have a W2 income. You can aggregate all your passive properties and use losses on one to offset gains on another. Your descriptions of each of your assets should warrant serious consideration of the benefits available to you. Why pay more than you have to in taxes?

Bonnie Griffin Kaake · Answer

@George Post You are not likely to qualify for RE Professional but your wife may. She would have to put in 500 hours of material participation, keep contemporaneous daily time logs and each year she would need to meet these requirements. You cannot add her hours and your to meet the 500 hours per year requirement. See the IRS Publican 925 under Passive Activity and At-Risk Rules (see pages 5 & 6). https://www.irs.gov/pub/irs-prior/p925--2018.pdf Look specifically for the 7 Material Participation Rules. You materially participated in a trade or business activity for a tax year if you satisfy any one the 7 tests listed. I do properties in all 50 states, and we/CSSI use the IRS's preferred methodology for our studies, engineering-based. Pre-analyses delivered within 2 days. Let me know if you have additional questions.

George Post · Answer

Thanks everyone! The past two years I made over $150k and have built up almost $11k in unused losses. I presume with this new property I will have more losses to show, and I am estimated to make less than $150k this year. So I am guessing I should have a decent tax return for 2022. I claim "0" ( I like the idea of a nice refund as a mini savings account for another property :)! So it the Cost Seg. is not a slam dunk must do? Also, my wife is a stay on home mother that is also heavily evolved with our rentals. Would she qualify as REPS?Thanks!