Cost Segregation for Real Estate Investors: How to Save Thousands on Taxes

Gian Pazzia (00:00)
what the sophisticated or the people that kind of figure out the game, what can you do with that eighteen to twenty thousand dollar savings on a three hundred thousand dollar rental home? Well, you could use it to help fund the next property, right? And kind of keep the cycle going. Yeah. That’s true. you put a down payment.

For the next property, you create more deductions, you save more taxes, you use that to put down payment on the next one, and that’s kind of how it builds upon itself.

Cody Crabb (01:59)
Welcome back to the Real Estate Pros Podcast by Investor Fuel. I’m your host, Cody Crabb, and today I’ve got Gian Pazzia with me.

Gian is the founder of KBKG, a national tax advisory firm specializing in cost segregation, and he’s also an active multifamily investor himself. Thanks so much for joining today. I really appreciate you giving us some time.

Gian Pazzia (02:18)
Thank you so much, Cody. I’m excited to be here.

Cody Crabb (02:20)
So just to start out, for people that don’t know you, I’d love if you could give us a quick little background of your experience and what you do and maybe even how you got into such a specific field. Cause it’s not something that you just got into. let me just say that.

Gian Pazzia (02:35)
Sure, Yeah, look, I was son of an immigrant parent, going way back and my dad got into real estate. he came over to the US when he was about twenty years old, basically had a pizza shop, yeah, as you can tell I’m Italian. but he kinda learned a long time ago that it’s better to use your savings on

stuff that improves in value versus goes down in value. And that’s kind of where I got the real estate bug a long time ago. But I didn’t fall into real estate right away. yeah, after college I ended up just falling into a job for a company called Arthur Andersen, which was one of the biggest accounting firms in the world. And I have a background in engineering, but and they wanted construction engineers to help them. And so

I fell into it and I ended up learning how to do cost segregation studies, which is something that a lot of real estate owners use now. It’s very common to basically write off parts of their building right away so that they can take big write-offs and essentially helps them do a lot of tax planning to avoid paying income tax. So

Yeah, that’s kind of my story. I fell into it. W we started this company, KBKG, over almost twenty eight, nine years ago, and it’s grown to be one of the biggest cost segregation firms in the US. and yeah, along the way I started seeing all my clients buy real estate and build wealth and started doing that myself. right now we have seven

income properties multifamily. it’s about forty units or so. And yeah, me and my wife are kind of doing that together as well as manage our business.

Cody Crabb (04:15)
Awesome. Well, so my first question would be like at what point did you see cost segregation specifically and go, there’s something here. Like I could I could do something with this. Like that’s what I’m curious about because it’s of course this is a strategy a lot of people know about, but like at what point did you go, people don’t know about this enough to actually do it themselves?

Gian Pazzia (04:32)
Yeah, when I fell into it a long time ago, it was absolutely not something that was super common. Like you could Google cost segregation when I when I got in the business and there’d be like three things that pop up. we founded our firm KBKG, like we’re one of the first to get into this space as an independent company outside of the Big Four big huge counting firms. And

I once went away from them, I was with KBKG and I started working with smaller real estate investors. Because before, when I was, growing up as a kid out of college, I was working for huge casinos and the pharmaceutical companies building these like billion dollar factories. But once I started working with the smaller investors that were buying, five million dollar buildings, not

hundred million dollar buildings, I started to realize just like how much of an impact these tax savings can have on people. And that’s really when the light bulb kind of went off. and it really started to spread like wildfire. Like people started doing cost segregation. My consulting business started to grow like crazy. and once I had enough

actual capital to start buying my own real estate is when I s when I started to acquire assets.

Cody Crabb (05:47)
So take us from these billion dollar companies down to these smaller investors. Like what you know, what w what did you start seeing once the regular real estate owners started to kind of get access to this strategy? Like what was the change? Yes.

Gian Pazzia (06:48)
Yeah. What did I start seeing? start is it seeing how you can plan around with cost segregation to essentially if you play your cards right, not just cost seg but with ten thirty one exchange and other planning strategies around tax, you can avoid paying any income tax. And it sounds crazy. It does, right? Like

How is this possible? what I can tell you is that Donald Trump he didn’t want to show his tax returns because he doesn’t pay tax. And the reason he doesn’t pay tax is because of the exact concepts that I’m talking about. He’s been in real estate, he’s built his wealth, and when you buy real estate and you start to it starts to kick off income, right, that you have to pay tax on, you can go out

And borrow from the bank and buy another building to create depreciation deductions. And these depreciation deductions that you can create really with the bank’s money can wipe out the tax that you’re paying on these other properties. And it’s this like cycle that when you step back and start looking, you can plan it out and essentially not ever pay taxes. And the reason is because what it is

It’s you’re deferring taxes. Okay. You’re wiping out taxable income in the current year with the promise to the IRS that you will pay that in the future. Because eventually you’re going to run out of depreciation deductions. And when you run out of the deductions, you’re going to have all this income. Well, the way the rules work is that you can keep deferring, keep deferring.

You can do 1031 exchange and defer. You sell buildings for a gain. Guess what? 1031, you defer. And then a lot of people do this, they figured it out. You once you pass away, the income tax, all the gains that you created throughout your life that you kept deferring, essentially gets wiped out when you pass away. It gets forgiven. That that’s the crazy thing. So when you ask,

What it was it that I saw? That’s what I saw.

Cody Crabb (08:51)
You were like, Wait, there’s no way it just completely gets forgiven, right? Yeah.

Gian Pazzia (08:55)
That’s what I saw. And look, you can Google this stuff. It’s the way it worked.

Cody Crabb (08:59)
And importantly, like this is this is one of those things where this is part of the tax code. Like, this is not a cheat, this is not a workaround, this is like how it works, this is how it’s designed to work. That’s right. So that I think that’s an important thing to call out too. Like, this is I’ve had plenty of like CPAs where I’m like, okay, like just please tell me that this is not sketchy in any way, right? Like, and this is this is one of those things where if you’re if you’re operating within the tax code to make sure that

You’re doing everything above board too. so t tell me kind of give me an idea of what it’s like to work with you. So like let’s say I’m a real estate investor, I want to see kind of what my options are as far as minimizing my tax. So walk me through like what would happen if I reached out to you and kind of what would happen next.

Gian Pazzia (09:43)
Yeah, I would ask you information about the properties you’ve purchased, how much you paid for it, when you bought it, what type of building it is. Those are kind of like the three key factors that tell me that really dictate how much in how much you can write off, right? So if it was like a restaurant, like you own some restaurant, like a

fast food restaurant, you’re just the landlord. There’s a lot of stuff inside that restaurant, like the piping in the kitchen that for the gas stoves and the sanitary piping and the electrical for all of the cooking equipment and then the dining room, yeah, decorative stuff. That was all built into the building, right? And all that stuff can be written off. So like a building like that, if you paid, let’s say a million dollars for it, you might get be able to write off,

four hundred thousand dollars of it, if it’s a restaurant. so step one is getting that information.

Cody Crabb (10:38)
it depends on what building it is. you look at the different types of things that are built in and then you can just go from there.

Gian Pazzia (10:42)
Yeah, so what we would ask is how much did you pay for the building? when did you buy it? What kind of building it is, and what’s the address? With that information, I can take it back to my team and fairly quickly we can come up with an estimate of how much the tax savings are going to be for you. so if you said you bought a one million dollar building and it was maybe an office building or an apartment building, we might come back and say, okay, in the first year you’re

gonna get maybe $200,000 of deductions, right? Those are deductions, which means if you’re at a 30% tax rate, those deductions are worth $60,000. That’s the tax savings in year one. and then we strongly recommend you talk to your tax preparer, your CPA, and make sure you run it by them, you show them what we provide and say,

Is this gonna work for me? And usually they’ll say yes. there are cases where they may say it’s not gonna work for you. and that’s really all dependent on your tax situation and other factors.

Cody Crabb (11:42)
So who’s the ideal avatar? They come into your office and you’re like, Okay, you’re probably gonna be a good fit. Like what type of person?

Gian Pazzia (11:49)
Yeah, definitely someone that’s considered a real estate professional for tax purposes, that makes this election. So people in real estate, people that this is what they do. they buy and sell real estate, they manage properties, they’re acquiring them. in these cases, because they meet this criteria of what’s can called a tax professional, real estate tax professional.

in the tax code, they’re able to use losses from real estate against any other income that they generate. Okay. That’s the key because if you were what’s called a passive investor, okay, a passive investor has limitations. A passive investor would be the doctor, okay, that has making a million dollars being a doctor and ends up buying a rental property. and

They could do a cost segregation on that rental property, but they might not be able to use those deductions against the income they make as a doctor. So that’s a passive investor. there are situations where you can use those deductions and it can be beneficial, but when you’re a passive investor, you just have to that’s where it’s really important to talk to your tax preparer and CPA. There’s a ways around, there’s tax strategies to

kind of get around it, which don’t want to get too deep into on this, but there’s definitely tax strategies and also I’ll say another good another good kind of slam dunk for cost seg is if mom and dad own real estate and they passed away. remember how I said

Things are forgiven at that point earlier. Well, in that situation, what happens is there’s this step up. So if they bought the properties for $100,000 and the properties are worth $10 million, normally, remember that $9.9 million gain that they kept deferring and kept deferring. Well, there it gets erased because the beneficiaries inherit the property, they get a step up in basis, meaning

All of a sudden now their basis is whatever the fair market value is ten million dollars. So if they sell the property the very next day after they inherit it, there’s no tax because they inherited it, the basis went all the way up to ten million dollars. they sell it for ten million dollars and they wouldn’t have to pay tax.

Cody Crabb (14:50)
So, for that doctor or dentist or kind of high income W-2 earner listening, are they kind of stuck with these passive limitations? You mentioned to me before we started talking that there is kind of a line to tell if you’re a real estate professional. Tell me more about that.

Gian Pazzia (15:05)
Yeah, sure. So the tests, if you look in the tax code, you can Google it. How do you become a real estate professional? the main test is you have to w work 750 hours or more doing real estate activities. And there’s a whole list of what that is, things like managing properties, acquiring properties, selling properties, et cetera, et cetera. if you can meet that.

definition seven hundred and fifty hours and you don’t spend any more time in anything else you meet the criteria. So if you were a doctor that spent 2,000 hours in being a doctor, 780 hours in real estate, well you spent more time as a doctor than you did in real estate. You cannot be a real estate professional. Okay. if you

or a part-time software engineer that only spent six hundred hours doing software consulting on the side, right? Six hundred hours and then you spend seven hundred and eighty hours as a real estate professional, you would qualify as a real estate professional. Now, if you’re a doctor and you’re spending all your time in your medical practice.

y there is an exception. If your spouse is a real estate professional and if you file a married filed filing jointly a joint tax return, you net it all together. So doctor own earns a million dollars from their medical practice, wife is considered a real estate professional. Now all of a sudden you can

take these deductions, these depreciation deductions from cost seg and use them against the income you’re making as a doctor in that scenario.

Cody Crabb (16:42)
And what kind of save I mean, what kind of savings are we talking about here? Like, I mean, give me a give me some yeah percentage number ’cause I I’ve just so people kind of get their head around like what does this actually look like when you apply it?

Gian Pazzia (16:52)
Sure.

Look, I mentioned cost segregation is the concept of writing off parts of the building faster. So if you bought, let’s say, three hundred and twenty thousand dollar rental property, single family rental property, three hundred and twenty thousand. Okay, step one is you have to separate the land from the building value. Because land doesn’t wear down. So you don’t get to write it off. So it the building part is

what wears down, right, over time. And so the IRS lets you write it off over time. So let’s assume $320,000 property that $50,000 is land. Okay. We’re gonna put that off to the side and what’s left is $270,000 of building that you get to depreciate over 27 years. Okay, so that equals $10,000 each year for 27 years to get you to $270,000, right?

That’s what you normally get. Now with a cost seg study, we would come in there and get as much as, probably on average between twenty and twenty-five percent of that building value written off in year one. Okay, so now you take twenty-five percent of two hundred and seventy thousand, and that’s close to about sixty eight thousand dollars. Okay, when do you do the math? So that’s sixty eight thousand dollars of deductions versus the ten thousand I talked about earlier.

So now you just got fifty-eight thousand dollars of additional deductions. Okay, that’s not savings, that’s deductions, remember. to figure out how much you’re saving on your taxes. if your tax rate is 30 or 35 percent, let’s say it’s 30 percent. what is that? 30 percent of 60, it’s like 18, to 20,000 of tax savings in the first year.

Cody Crabb (18:34)
Yeah, I mean, that’s significant. that’s so significant that like people’s ears should be perking up if they’re in the kind of arena for this, ’cause that’s worth doing some extra legwork for I would

Gian Pazzia (18:44)
Yeah.

Well, and what the sophisticated or the people that kind of figure out the game, what can you do with that eighteen to twenty thousand dollar savings on a three hundred thousand dollar rental home? Well, you could use it to help fund the next property, right? And kind of keep the cycle going. Yeah. That’s true. you put a down payment.

For the next property, you create more deductions, you save more taxes, you use that to put down payment on the next one, and that’s kind of how it builds upon itself.

Cody Crabb (19:12)
Yeah. Wow. Well, this is cool. I thank you so much for giving us this. I love when we get somebody on that is a like a real that can we can drill down it really granularly on something like this because it really gives our audience something valuable. so let’s say people wanna look into this and they think that they might be a good fit to get to get some of these benefits here. how could they reach out to you if they want to reach out to you and work with

work with you well how can they how can they do that? Well maybe not work with you directly.

Gian Pazzia (19:40)
Yeah, look, Gian Pazzia There’s only one of me in the entire world, first off. So you can Google Gian Pazzia, G I A N Pazzia. But a couple other things. I have other companies that we’ve launched under the KBKG umbrella. we created CostSegregation.com, right? we’ve owned this website for almost twenty eight years, back then when nobody had it. And we created a self guided software to help.

Smaller real estate investors do these cost segregation studies. normally they cost five thousand dollars, but our software brings the price down to five hundred dollars. Okay, so it makes it make sense to do this. You can find that on CostSegregation.com. And I’m gonna give you guys a promo code to use it with 10% off. that promo code is R E Pro.

two six. Okay. Awesome. REPro26.

Cody Crabb (20:32)
We’ll make sure you put that in the description. Yeah, go ahead.

Gian Pazzia (20:35)
Yeah, and then the other thing that we talked about the real estate professional status, because I a lot of real estate or people trying to get into real estate ask about this question. We created a phone app called Track750. And it’s to specifically help investors track the seven hundred and fifty hours that are needed to meet that criteria. Okay. And I’m giving it away for free.

to your viewers. that’s So if you want to check out that app, it’s track750.tax and the code to get it free is track L I G I A N that’s it. TRACK L I G I A N and you’ll get it for free.

Cody Crabb (21:17)
There you go. Awesome. I love when we get little free previews like that. So we really appreciate it. Thank you. well, yeah, everyone go check that out. if it sounds like you’re on the line of maybe like, am I a real estate professional? Sounds like that’s a perfect way to find out, maybe a good start to see if this is gonna apply to you in some ways. I can’t thank you enough for coming on here, Gian. This has been a great, great episode. listeners, if you’ve got something out of this episode, make sure you stay tuned for the next one and

We’ll take care. see ya next time and thanks for joining us today.