“How much will I save in taxes this year if I buy real estate?”

[Melanie Baldridge]

Here is a framework to think about how buying properties creates the most tax efficiency for you.

The 6 levers of depreciation:

Lever 1 - % of Land

One of the components of a property is land.

Land is NOT DEDUCTIBLE, so low value land properties mean more tax deduction.

A value of your overall purchase will be assigned to the land or lot.

You receive no near-term tax benefits for buying land.

For example - If you buy a $2 MM industrial building outside a rural town on 5 acres, the land value could be $5k an acre. The land represents ~1% of the purchase

On the contrary - if you purchase a $2 MM shack in manhattan on a postage stamp lot, the land could represent 99%

Lever 2 - % of the property with a shorter useful life.

Not all parts of a piece of real estate are depreciated at the same speed.

Certain personal property assets have SHORTER lifespans in the eyes of the IRS vs the standard 27.5/39 year lives

Properties with tons of this often have:

- Over-developed land sites (hardscaping, pools, retaining walls)
- Fancy Fixtures
- Fancy Furniture (STRs!)
- Lots of Equipment (R&D Facilities, Car Washes)
- Gas Stations (100% 15 year properties)
- Movable walls (self storage)

You can find anywhere from 15-35% of the purchase price of a typical apartment complex is this type of property.

More of it means less tax for you from higher depreciation amounts!

Lever 3 - % of Leverage

This is a big one! The more leverage (debt) that is applied to a property or deal, the more cost savings you will get up front relative to the equity you put in.

Let's say you buy a $10 MM dollar deal that has $3 MM of year one depreciation.

If you used $7m of bank debt and only $3m of equity, your year 1 deduction will equal the amount of money you put into the deal!

If you had used cash for the full $10 m, you would get a deduction worth 30% of your investment.

(remember, more debt = more risk)

Lever 4 - % Tax Rate

Another HUGE consideration.

Depreciation is a deduction that you are allowed to take at your Marginal Tax Rate. Similar to a 401k, part of the strategy is a tax arbitrage.

It is a much better outcome to take the deduction at 37% rather than 24%.

Lever 5 - % Bonus Allowed

In 2023 Bonus depreciation has been limited to 80%, and will continue to ramp down 20%/yr until it hits zero in 2027.

Bonus depreciation has come and gone in the past, but the more you get, that first year payback is higher and higher.

Lever 6 - % Payback Ratio

Ultimately how much you save vs. how much you pay matters.

Caveat - Talk to your CPA before you purchase a cost seg study.

You need to have a way to monetize your losses through

1. Being a Real Estate Pro
2. Having Passive income you can offset
3. Using the STR (or carwash, etc..) Loophole

Don't cost seg if you can't use the losses!