How to Scale Commercial Real Estate

Feb 18, 2022

If you’re still confused about cost segregation, stop what you’re doing right now and listen to this episode.

Erik Oliver, Managing Director at Cost Segregation Authority, serves as a consultant for real estate investors who want to save tax dollars from their investments. He helps his clients increase their cash flow by applying cost segregation, the process of giving valuations to individual assets for federal tax deduction purposes.

He also provided a quick deep-dive about bonus depreciation and tells us how investors can utilize it in their deals. 

[00:01 - 02:40] Opening Segment

• Erik Oliver tells us why he is in the real estate business
• • How he applies his accounting degree in real estate
• The exact role that he plays as a consultant

[02:41 - 08:49] Crash Course on Cost Segregation

• Why would an investor do cost segregation?
• • Erik explains
• Erik tells us how his team accelerates deductions in their properties
• How a depreciation recapture works according to Erik

[08:50 - 18:16] What Investors Should Know About Bonus Depreciation

• He reveals the reason commercial real estate is a 39-year asset class
• • …and why residential is only 27 years
• The simple explanation of depreciation
• • Every asset has a unique depreciation life, and here’s why
• The properties eligible for 100% bonus appreciation have this characteristic

[18:17 - 19:57] Closing Segment

• Reach out to Erik
• • See links below 
• Final words

Tweetable Quotes

“Manage the allocation of your sales price and put that into the right buckets, which allows you to reduce your total tax bill upon sale.” - Erik Oliver 

“...depending on the structure of the deal, your depreciation doesn't have to be divvied up equally amongst your investors..” - Erik Oliver 

“We still have a couple of good years of quality bonus depreciation available to us. So, definitely keep that in mind as you're investing and looking at different properties.” - Erik Oliver 

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Email erik@costsegauthority.com to connect with Erik or follow him on LinkedIn. Do you want to save millions of tax dollars? Visit Cost Segregation Authority to learn how. 

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I love helping others place money outside of traditional investments that both diversify a strategy and provide solid predictable returns.  

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Email me → sam@brickeninvestmentgroup.com

Want to read the full show notes of the episode? Check it out below:

Erik Oliver  00:00

When you buy an asset, let's say you buy an apartment building, you're not just buying the land in the walls, you're also buying a bunch of appliances. You're buying a bunch of ceiling fans, you're buying a bunch of garbage disposals and a bunch of flooring and all these different assets, and according to the IRS, those assets can be depreciated at a much faster rate than 27 and a half years and that example. So carpet, for example, should be depreciated over five years, your appliances should be depreciated over five years. But when you pay 2.8 million for it, you don't know how much of that 2.8 million is for refrigerators or garbage disposals. And so that's what a cost segregation company does is we come in and we segregate those costs into different buckets. 

Intro  00:37

Welcome to the How to Scale Commercial Real Estate Show. Whether you are an active or passive investor, we will teach you how to scale your real estate investing business into something big.

Sam Wilson  00:49

Eric Oliver is the managing director at cost segregation authority and his work with clients across the country saving significant tax dollars. Eric brings with him a passion for identifying cost savings and educating real estate investors. Eric, welcome to the show.

Erik Oliver  01:03

Hey, thanks for having me, Sam. Glad to be here.

Sam Wilson  01:05

Pleasure’s all mine. same three questions I ask every guest who comes on the show. Can you tell me in 90 seconds or less, where did you start, where are you now, and how did you get there?

Erik Oliver  01:13

Yeah, sure. So I started my background is in accounting. So my major in accounting never really wanted to be a CPA, I was just numbers always came easy to me. And I'm horrible at English. And so I said, Hey, I'm going to go into a math degree. So I have an accounting degree. And my background is in sales. I've been in sales for the last 20 years. And so I was looking for a job, I lived in New York for a long period and wanted to move back out west and was looking for a job and came across this company. They've been in business for about 16 years now. And I thought it would be a good fit with my accounting degree and my business development background. And so I joined their team been here about six years now. And loving it, love helping investors. It's the, I gotta be honest with you, it's the easiest sales job I've ever had. It's a math equation either makes sense or it doesn't, right. So I love that aspect of it and glad to be here with this company.

Sam Wilson  02:04

That's fantastic. I love that. Yeah, your sales job, I would only imagine is pretty easy in the sense. It's like, “Hey, by the way, I can help you save a loads of money.” Yeah, a little bit upfront. Like…

Erik Oliver  02:15

Right? That's exactly what it is. It's, you know, you can give me 4,000, and I'll save you 40. Or you can pay the IRS 40. In April you decide and so, right, it's really more of a consultant position, which I love is just kind of walking people through how this works and exit strategies and you know, different investment strategies that we see with the investors we work with. And so that's the part that I really love. It's not like I'm trying to convince somebody they need to do it. It's more of a consulting and I love that aspect of the job. 

Sam Wilson  02:41

Great. We've certainly had several different firms come on the show and talk about cost segregation, we've dived, I mean, like you said, English isn't isn't our strong suit, whatever we did, we got into those, you know, kind of some of the nuances of cost seg. And you know, that was a good time. But just in case, our listeners haven't listened to that episode, can you give us just a I mean, bite size, what is cost segregation? 

Erik Oliver  03:03

Sure, Cost Segregation is just accelerated depreciation. So when you buy an investment property, you get to depreciate that over either 27 and a half or 39 years, depending on the asset. And so you're taking 1/27 or 1/39 of that the building price in terms of depreciation over those ports of years, and all we're doing is saying, well, instead of taking 1/39 of your storage units, what if you could take 30% of the deductions in the first year, and spread out the rest of the 70% over the course of the next 38 years. And so there's a number of reasons why you would want to front-load your deduction, you know, you've got time value of money, big one right now is inflation. You know, $1 today is worth more than $1, yesterday, or even an hour ago. So there's a number of reasons why you want to frontload those deductions, give me my deductions today, I'm not going to hold my storage unit for 39 years. So give me my deductions today. Let me put that money to work on my next storage unit or what-not. And so that's really what we're doing is front-loading depreciation deductions.

Sam Wilson  04:00

Gotcha. Yeah, that's really your point there that $1 today is worth more than $1 for tomorrow, not tomorrow's dollars worth less than today's dollar. That's one thing. And the other thing you pointed out there is that, you know, if you have a 39, say, 39-year or 30 and a half 39-year deductions, yeah, yeah, you have that. I mean, by the time 39 years from now, I don't really plan on I mean, minus passive income and assuming I'm still alive, like, it just it doesn't make any sense to pay taxes like I'm in the highest-earning tax bracket right now. Right? The more deductions I can as a person, either a passive investor get on my k-one or even an active investor, right? More deductions, I can bank today, the better off really I am in the long term. That's really fascinating, you know, but with that one of the topics that we haven't spent a lot of time digging into is one, most of us don't hold these properties for 39 and a half or 39 years or 27 and a half years even, it's just not the way it is. And there's a few people that say Oh, I’ll hold is in perpetuity. Okay, good for you, but the normal business plan is five to seven-year hold on a lot of these larger commercial assets, because we all bring in investors, and then we got to make them their pile of money and give them their money back. So what happens then, like Orleans, we haven't dug into his depreciation recapture? I mean, it just seems like, are you just trading dollars at that point? And when you pay the tax? What's that look like? 

Erik Oliver  05:18

Yeah, that's a great question we get that, get asked that quite often. And I'll kind of just back up a little bit just to shed a little bit of light for those listeners who aren't familiar with how we accelerate those deductions. What we're doing essentially, is we're just, when you buy an asset, let's say you buy an apartment building, you're not just buying the land in the walls, you're also buying a bunch of appliances, you're buying a bunch of ceiling fans, you're buying a bunch of garbage disposals and a bunch of flooring and all these different assets. And according to the IRS, those assets can be depreciated at a much faster rate than 27 and a half years in that example. So carpet, for example, should be depreciated over five years, your appliances should be depreciated over five years. But when you pay 2.8 million for it, you don't know how much of that 2.8 million is for refrigerators or garbage disposals. And so that's what a cost segregation company does is we come in and we segregate those costs into different buckets. And the reason that's important is think about it when you buy an asset. Let's go back to your question on recapture, I'll kind of back into this. But if you buy a building, let's say you buy an apartment building for $5 million, and you hold it for five years, and you sell it five years later, for 10, the markets great, you've doubled the value of the property's doubled. You sell it for 10. When you go to pay taxes on that, if you don't do a cost seg study, you're telling the IRS that everything doubled in value, my land is worth double, my walls are worth double. And guess what, so is my dirty old carpet that I've had for five years, it's now worth double what I bought it for five years ago, right? That's just not the case, carpet doesn't go up in value, carpet goes down in bed. But when you have everything lumped together as one big asset, that's all you can do is say, “Well, this asset I bought for five, this big asset I sold for 10. So everything doubles in value.” When you do cost segregation, you've got everything broken up into different buckets now. And because we have it broken up into different buckets, I can say what are my five-year assets worth after owning that building for five years, they're worth zero, they're fully depreciated, right? And so you're not selling your carpet for more than what you paid for it, you're selling it for zero, it has zero book value in that example, because I've owned it for five years. And so when you do cost segregation, it allows you to manage those recapture taxes. And essentially, what you're doing is you're taking your deduction at a high rate, taking it against that high 37% federal tax, federal income tax, you're taking your deduction of 37%, you're paying back a portion of it, and that portion is dependent upon how long you own it, you're paying back a portion of it at a lower rate at a future date and saving the spread. And so when you're paying that back, if you're paying it back at a capital gains rate of 20%, and taking the deduction at 37. Even if you're paying it all back, you're still saving that 17% spread. And like I said, in actuality, you're not paying it all back. Because in that example, your five-year assets are fully depreciated. So you're paying no recapture on your five-year assets. And so you're only paying parts of that recapture at a lower rate. And so that's one of the side benefits. I don't know if it's a side benefit. But it's one of the secondary benefits of having a cost segregation study done is give me my deductions now. But then when I sell the asset, I'm able to manage the allocation of my sales price. Again, that's important, manage the allocation of your sales price, and put that into the right buckets, which allows you to reduce your total tax bill upon sale. And so hopefully, that wasn't too far in the weeds. But I think, you know, the main point there is you're not selling your carpet for more than you bought it for. Right, take your deduction at a higher rate, pay back a portion of it at a lower rate at a future date and save the spread. And that's really what we're trying to accomplish.

Sam Wilson  08:50

Right. Yeah. And I think that's an interesting clarification that a lot of people don't have when, when they're being sold these investments when you're talking to passive investors, right? Like, hey, you know, 100% bonus depreciation 100%, this, like, blah, blah, blah, cost seg, they don't tell you that, hey, on the back end, you're gonna capture some of this again, it just might be at a much lower rate. So I mean, and again, you know, for a lot of passive investors, they care but they don't care in the sense of like, I'm coming to you to put a deal together to make me money. And you're getting really in the weeds there, Sam. So yeah, just send me my k-1and tell me what it is. Let's go.

Erik Oliver  09:29

Right. And that's something to that we talked to investors about or just something to keep in mind in terms of cost segregation, and when you're putting these deals together is depending on the structure of the deal, your depreciation doesn't have to be divvied up equally amongst your investors. I mean, you can put in your operating agreement that you know, you might have some investors who are high W2 earners, and they're not real estate professionals and they're just looking for a place to park their money and they don't necessarily need the tax deductions or can't utilize them versus some investors that are bringing money to the table. All they're looking for is a tax write-off. And so being able to kind of mix and match with your investors, what you're giving them in terms of tax write-offs by utilizing some of these cost segregation strategies is key to finding new investors and being able to provide for them, you know, what they're looking for whether it's, are they looking for equity long term? Are they looking for a tax write-off in the short term? And so that's one of the added benefits.

Sam Wilson  10:21

Right, now, that's a great point. Yeah. Because I think about, you know, separate self-directed IRAs, you know, Roth, IRAs, things like that, that I have. And I mean, the deals were in that I use myself, I don't need to, you can give me all the write-offs you want. I don't care. They don't care. Yeah, doesn't do me any good. I wonder if, you pose an interesting thought there, which is not part of our onboarding process right now. But I wonder if that's probably a good question to put in your investor questionnaire as they come on board. Do you need the appreciation benefits or the cost seg benefits as we like, is this something you can even use? Right? If not, we're going to have our accountants funnel this to other, you know, split it up evenly amongst the investors that do need it.

Erik Oliver  11:00

That, do need it. And maybe that those who don't need it, maybe they have more equity in the deal or whatever, however, you want to structure it. But yeah, give them what they're looking for. And it does help when you're raising money to be able to tailor your offering to what they're looking for and what their needs are.

Sam Wilson  11:14

What's a good way to explain cost segregation or depreciation to an investor? Because I mean, I've got a lot of people that this is such a, especially non-business owners, right? To me, it took me a while to wrap my head around like, Wait, so I'm gonna put money and I'm gonna make money, and then I'm gonna lose money.

Erik Oliver  11:31

Right?

Sam Wilson  11:32

How does this third-grade math tell me this doesn't work? Right? But yet it does. So what's a good way when talking to investors? Do you think that people should be saying, Hey, this is maybe someone's never heard of depreciation, or bonus depreciation, or short offset like,

Erik Oliver  11:47

You know, depreciation, it does take a little bit to get your head around. But it really is a non-cash expense. So when you think about business, we have income. And then we have our expenses, right? So whether you're manufacturing widgets, you got to buy the parts for the widgets, and those are your expenses. And then you sell those parts, that's your income. And your income minus your expenses is obviously your profit. And depreciation is just a non-cash expense. It's no different than, you know, people at the end of the year, they go out and buy a truck to try and get a write-off. Depreciation is the same effect, the same thing. It's just non-cash. And the other way to look at it is everything deteriorates over time. And so basically, if you think about, you know, sometimes people say, Well, why are commercial properties 39-year assets, and residential 27 and a half. And the thought process there is, is that when you've got somebody living in a building 24/7 or potentially there 24/7, where you've got a commercial building that's open nine to five, that commercial building is going to last longer. All the stuff in it is going to last longer than something that's being used 24/7. And so we've got these different depreciation lives. And there's court cases where all these depreciate, Oh, someone said, at one point, there was a court case that said, “you know, my carpet doesn't last 39 years, and so I shouldn't be depreciating it over 39 years.” And so then the court said, “Yeah, you're right, carpets, you know, only last five years. And so carpet now has a depreciable life of five years.” And so that's really all it is. It's just the depreciation, and how long does it take that asset on average, to basically become worthless. And so if you had a commercial building, let's say you had a storage unit, in theory, if you own that storage unit, you built it and owned it for 39 years and never maintained it. After that 39 years, it would be worth zero, right? And that's kind of the thought process behind it. So because of that, you get to take these write-offs, because every year it's worth a little bit less than a little bit less in terms of the structural value, not necessarily the market value. You know, obviously, things go up depending on the market, but the structural value goes down. That siding is now five years old. And so it's not worth as much as it was when you put it on their original. And so I don't know if that was an easy way to describe the depreciation.

Sam Wilson  13:55

No, I think that's really good talks about bonus depreciation. There's a lot of concerns coming down, you know, you see the chatter on the internet machine. And it's all, you know, hey, you're bonus depreciation go going away, blah, blah. Can you tell us quickly what is just for our listeners? What is bonus depreciation and talk to us about the sunsetting of it and kind of what's happening on that front?

Erik Oliver  14:16

Sure. No, that's a great question. So bonus depreciation has been around for a while, and it's kind of a way the government has used depreciation to stimulate the economy. And so they have, you know, depending on how they in the past, depending on how the economy was going, they would either increase the bonus or decrease the bonus on what they were trying to accomplish. And what bonus depreciation is, is that I think originally bonus depreciation was set up to not for real estate. So when you think about bonus depreciation, it was on assets that have a depreciable life of 20 years or less, right? So the idea was, hey, if you go buy a new truck, we're going to allow you to take 100% of the depreciation in the first year versus spreading that out over X amount of years. Whatever the depreciable life of a truck Is, or a bulldozer or a piece of machinery, right. However, when you think about cost segregation, when you buy a 27 and a half year asset and you do a cost seg study, now we're coming in, and we're segregating into five, seven, and 15-year buckets. Well, those five, seven and 15-year buckets are all under 20 years. And so now they're eligible for bonus, right? And Trump knew this, Trump being a real estate investor, and we won't go down that rabbit hole, whether you like him or not, that's up to you. But he is a real estate investor. And when he rewrote the tax laws or the tax codes, he was very favorable to real estate investors, and he understands how bonus depreciation works. And so he extended bonus depreciation to the end of next year, so any properties purchased between September 27 of 2017 and December 31 of this year 2022, are eligible for 100% bonus. And what that means is, is that when we do a cost seg study, all the five, seven and 15 year assets that we identify, instead of depreciating your five-year carpet over five years, you know, you get roughly 20%, every year for five years, you get to take 100% of that in the first year, right. And so this is big because when you buy a million, let's say you buy a million-dollar asset, we typically segregate somewhere around 30%. So all of a sudden, you're getting a $300,000 write-off in the first year with bonus depreciation. 

Sam Wilson  16:21

That's nice. And even if you don't use the entirety of that write-off that year, that right off carries forward until you've used all of it. 

Erik Oliver  16:26

Correct. Yeah, you don't ever lose it.

Sam Wilson  16:29

So what happens to the sunset? When is this going away? Because I know there's a phased out, they're phasing this out on this, what is that?

Erik Oliver  16:35

Yeah, and so, exactly. So they were talks about, you know, with the new administration coming in, were they going to keep this 100% bonus in place, or were they going to get rid of it, there was talks about them getting rid of it. So far, in the stuff that's been proposed, bonus depreciation has not even been mentioned, which is great. And so the current phase-out period is, it's 100% for anything through the end of this year. Now, that's any asset you buy through the end of this year. So let's say you don't do a cost seg study on the on an asset you bought this year, you don't do the cost seg study for two years, you're still eligible for that 100% bonus, a law applies to the time you purchased or put the building into service. So anything you buy between now and the end of the year is eligible for 100% bonus, and then starting anything purchased in 2023, it starts to phase out 20%. So now you get 80% bonus. So now if you've got $100,000 worth of carpet, for example, you get to take 80,000 of that in the first year, the 20,000 then gets played out over the next four years, right. And so same thing with your seven and your 15-year asset. So it starts at 100, next year goes to 80. The following year, it goes to 60 and 2027, it's down to zero and that's assuming nothing changes but you know, we still have a couple of good years of quality bonus depreciation available to us. So definitely keep that in mind as you're investing and looking at different properties. 

Sam Wilson  17:53

Man, this is fantastic, Eric, thank you for taking so much time today to really break down even further and nuance into cost segregation this is I don't think we've quite gone this deep on some of these more nuanced parts of this especially the sunset provisions there on bonus depreciation that's something that I think our listeners will find very very helpful because there is again like you said a lot of chatter around it. So yeah, that's been absolutely fantastic. Last question for you, if our listeners want to get in touch with you do business with you learn more about you can you tell us the best way to do that?

Erik Oliver  18:24

Sure. Absolutely. So our website is just costsegauthority.com. That’s C-O-S-T-S-E-G, authority dot com. From the website, my contact information is on there, please use me as a resource. If you have any depreciation questions, feel free to call me, if you've got child tax credit or earned business income questions, please don't call me because I can't answer those. But anything depreciation-related. We're kind of a niche accounting firm, we just do cost segregation. So trying to think the weirdest question I think I've been asked is how to depreciate mule deer for a breeding farm in Wisconsin, they were, breed these deer and believe it or not, deer have a depreciable life of X amount of years. And so we got that question. I didn't know the answer that right off the top, but I was able to find the answer. So if you have any depreciation-related questions, 100%, please feel free to call me my email is on there, my phone numbers on there. From our website. If you do have properties, we do a free benefit analysis on your property. And we'll give you an idea of what the fee would be to do the study as well as what your expected tax savings would be. So feel free to reach out to us that way. It's been great, Sam, I appreciate your time. Glad to be here.

Sam Wilson  19:29

Eric, thank you so much. Have a great rest of your day. All right, you too. Take care. Hey, thanks for listening to the How to Scale Commercial Real Estate Podcast. If you can do me a favor and subscribe and leave us a review on Apple Podcasts, Spotify, Google Podcasts, whatever platform it is you use to listen, if you can do that for us, that would be a fantastic help to the show. It helps us both attract new listeners, as well as rank higher on those directories. So I appreciate you listening. Thanks so much and hope to catch you on the next episode