How Cost Segregation Helps Rental Property Owners Reduce Taxes & Keep More Cash Flow

AJ Lyons (00:00)
⁓ But really, cost seg, just regardless, it makes sense to do. Why not keep that money in your pocket rather than paying it to the IRS and either keep it in your pocket or use that to cash flow your next investment and sort of help build your portfolio. So.

I always say that cost seg should never be like the only reason that you’re doing an investment property and it should be the cherry on top.

Cody Crabb (02:01)
Welcome back to the Real Estate Pros podcast. I’m Cody Crabb and today joining me is AJ Lyons, partner at DIY Cost Seg, where he helps multifamily and commercial real estate operators across the country use cost segregation to improve tax strategy and get better cash flow. We’re going to talk about what investors need to understand about Cost Seg, what it even is, where people can get it wrong sometimes, and how smart operators can actually take advantage of it and use it more strategically. AJ, thanks for joining us today.

AJ Lyons (02:28)
Thanks for having me Cody, I really appreciate you taking the time.

Cody Crabb (02:31)
So my first question ⁓ is, we have a lot of people that listen to this show that are kind of new to the real estate world. They’re looking at it and they’re seeing all the benefits and they love the idea, but they’re just learning about it now. Can you give us a super quick summary before anything else about what CostSeg is?

AJ Lyons (02:50)
Yeah, totally. So, cost seg is a tax strategy that accelerates the depreciation that you already get to take. So, it helps you… ⁓

create passive losses, essentially, you know, paper losses. your rental may be actually cash flowing, but we don’t want you paying that money to the IRS or to the tax man. Let’s make it look like on paper that, you know, the property isn’t ⁓ producing that income and you’re just able to show a paper loss. But essentially high level, it’s like, if you imagine a pie right now, when you place your ⁓ rental into service, it’s all in just one whole pie. It’s not cut up into anything.

So when a rental is placed into service, it’s placed into service in long life. So that’s over 27 and a half years for residential rentals and 39 years for commercial rentals. So you’re getting a little bit every single year over that 27 and a half years or 39 years until the property is fully depreciated. What CostSEG does is it comes in and identifies the portions of that pie that we can accelerate per the IRS guidelines. So we go in and we say, hey, you know, this slice here can be taken in five years.

This slice here can be taken in 15 years So we’re accelerating that depreciation that you already get to take over the lifetime of 27 and a half years of 39 years We’re just accelerating how quickly you get to take that and then with bonus depreciation in play That’s allowing you, know, when it’s 100 % bonus depreciation to be able to take it all year one So that’s essentially what it is at a high level

Cody Crabb (04:18)
Gotcha.

Okay, that’s really helpful. who’s the kind of person that should really be paying attention to this? Like what situation would you be in to be like, yeah, this is something you want to look into for sure.

AJ Lyons (05:17)
Yeah, so I mean really anyone who is in real estate investing full-time or even part-time at this point ⁓

There’s really no reason to allow it to just depreciate straight line and let the government just give you a little bit back, you know, every single year. ⁓ Accelerate that depreciation. That’s going to free up cashflow for you, whether that’s to put that into new projects and into your next, you know, real estate rental. ⁓ Or if it’s just to keep a little bit more money in your pocket and not pay as much in taxes that year. So if you’re, you’re in the rental game, it makes sense to do a cost seg.

especially now that we’ve really opened up the space a bit more back in the day. People thought, know, it’s only for rental properties that were worth multiple millions of dollars, know, millions of dollars spent because in the traditional sense, you know, a fully engineered cost segregation report, someone’s going out to the site, they’re coming back, it’s taking months to produce that report, you’re getting that report and it’s costing you, you know, at a minimum like five, $6,000. So it was really

cost

prohibitive for some of those lower single-family residences, know, $300,000 less than that. just, the math didn’t make sense when you’re paying that much for the report. It ate up all the benefit that the report was giving to you. So we’ve really tried to, you know, allow more people to come into the space by lowering the price and changing the way we do things.

Cody Crabb (06:39)
Gotcha, okay.

All right, now let’s do a full rewind ⁓ and do a, well, usually I start with this, but just to kind of give some people some background about what Cost Seg is. ⁓ So tell us your story. How did you get involved in this? ⁓ What ⁓ led you here and kind of what does your business look like today?

AJ Lyons (06:55)
Yeah.

totally.

So I actually worked for our sister company about ten years ago. We have a sister company that does the fully engineered cost seg reports. So I was in just the real estate industry as a real estate agent, property manager, that sort of thing to begin with. I got the job with our sister company and sort of learned the ins and outs of cost segregation from them. So that was, you know, like traveling two weeks out of every month and doing those site inspections to gather that information.

come back, produce the report, and then do it all over again. About eight years ago.

we were just talking and we realized with the way technology is going and the world is moving, some of these other industries just aren’t keeping up in that same vein. So we said, hey, we could bring cost segregation to a broader audience by bringing it online. instead of someone going out to the site ⁓ to gather that information that would typically be gathered ⁓ on the site visit, let’s get that directly from the client or their CPA.

tell you know a bunch of forms where you know we went through and said hey these are all the things that we’re looking for in the checklist that we’re using while we’re out on site. ⁓ Let’s you know just get that information directly from the client and that’s sort of how DIY was born. Obviously you know it’s not just me I have other co-owners as well and their backgrounds in engineering. The other one was a contractor for the state of Florida for over 20 years and then we have another ⁓ advisor who has their masters in real estate tech.

So it’s really a team effort and just trying to bring cost segregation is sort of the

intersection of engineering, tax, construction, real estate. So you need all of those components to come together and to create, you know, a cost seg report. So I came more from that real estate background and learned the cost seg side of things, whereas some of the other co-owners, they came, you know, from the architecture engineering background and the construction background, also learned the tax side. And then we obviously have our partner who, you know, focuses on the tax side a bit more.

Cody Crabb (08:53)
Mm-hmm.

Gotcha, okay. So I like the team effort. That’s a good way to frame it. So for an investor listening, what are some of the biggest mistakes you see investors make?

AJ Lyons (09:59)
Obviously, we all find out about cost seg at a different time. So if you’re just now finding out about it, don’t feel like it’s necessarily too late. There will be times when it when it is. And that’s just because you’ve taken so much in straight line depreciation. You know, if you bought the property back in 2005, it’s it’s already been 20 years. We can’t accelerate anything into those 15 or five year categories because you’ve already taken a straight.

line. So there are times when we tell clients that come to us like, it just doesn’t make sense on this property because of how much straight line depreciation you’ve already taken. ⁓ But if it’s been five, maybe even 10 years, it turns into a bit of a math problem that you’re going to want to do with your CPA just to make sure that it’s all making sense with how much you’re paying for the report, the report benefit that you expect to receive, and then, you know, will it make sense? ⁓ But there, that is one of the main things that we see is people just not knowing about

it and it being a bit too late to jump in, ⁓ you know, or if it is in that like five, 10 year range, there are a few more like hoops that you’ll need to jump through just in regards to a form 3115 section 481A adjustment from your CPA that basically what that does is says, hey, I didn’t know about cost seg, you know, I know about it now, I want to go ahead and take that benefit. ⁓ So they have to adjust your previous year tax returns via that form to allow

you to say, Hey, I know about it now. I got the report done. Let me apply this. if it’s only been one year since the property has been placed into service as a rental, ⁓ you’re, could just amend your previous year’s tax return. so it’s a bit simpler at that point, but that’s why we always say like the best time to do cost seg is when you first purchase the property and place it into service as a rental, it makes the most sense from a cost seg perspective. And it’s sort of top of mind for you. You, you know, you’re, you’re in it, you’re knowing all the details, you know, then

because you’ve just got the deal done, it’s top of mind for you as well. So that’s definitely one of the things that people sort of just miss out on or make the mistake of, if we want to call it that, of just not knowing about it and not reading.

Cody Crabb (12:03)
Gotcha, so it’s one of those like

best time to start working out is 10 years ago, but the second best time is right now. Gotcha, yeah. Okay, so that begs the question then, is there like a situation where a property is too small or a deal is too simple or it’s something like that where it doesn’t make sense? Because that’s the kind of thing where I like to zero in on those things for our audience.

AJ Lyons (12:10)
Exactly. Yeah, that’s a great way to put it.

Totally. So

a few things to that point. One,

With the traditional fully engineered studies, there was definitely a point where it didn’t make sense because like we were talking about earlier, just that cost prohibitiveness of if you’re paying at a minimum $5,000, $6,000 and up from there depending on the property and the cost basis and scope of the project, it’s just not going to make sense for a single family rental where you paid, depending on where you’re at in the country, $150,000, $300,000, something in that range.

⁓ What we’ve done with DIY cost seg is we’ve brought that price down. ⁓

ways that we’ve done that is we’re gathering that information that would have typically been gathered on a site visit directly from the client and then utilizing our software to produce that report for them instantly. So I actually have a couple examples here of sort of like the really low end that we’ve still seen people that have used our. Perfect, yeah. So the lowest report that I’ve seen on our website run. So when I say cost basis, that’s going to be purchase price minus land value.

Cody Crabb (13:22)
Yeah, I’d love to hear a little bit about those.

AJ Lyons (13:35)
because land is non-depreciable, so we can’t include that. We always remove the land value from the study. So someone came in with a single-family residence in Kansas. Their cost basis was $37,000 for the whole property. Obviously, that’s not indicative of the whole country. know, there are those pockets where you could find deals like that still. But we identified $11,000 in depreciation that we were able to accelerate for them.

So what that turns into,

and this is just an example, everyone’s tax bracket and tax situation is obviously unique. So they’re gonna want to check in with their CPA, but say they were in the 37 % tax bracket, that $11,000 in accelerated depreciation turns into $4,000 of actual tax benefit that first year where they could reduce their taxable income by that $4,000. So with our website reports on the residential side, it ranges from $495 to $995.

$495

depending on the cost basis of your project as soon as price and land value are put in it lets you know where you fall in that range for this client they obviously were on the low end of that range so they only paid $495 for the report so they still received around you know $3,500 $3,700 in actual tax savings you know for that report they purchased in the past that wouldn’t have been possible with a fully engineered study someone going out to the site just the the cost that they would charge for

for that would have eaten up all of the benefit that that person could have expected to get from that property. On the other end, our highest project that we’ve worked with was a hotel with a $14.5 million cost basis, so completely other end of the spectrum. And we were able to identify two million in accelerated depreciation on that project.

Cody Crabb (15:47)
Gotcha.

Wow.

AJ Lyons (16:04)
So we could help either end at this point just because of the changes that we’ve made in our process that we take with our online offering. I’d say our sweet spot is probably in the $150,000 to a million dollar range. That’s where I see most of the reports coming in at cost basis wise. But obviously we can help on either side of that as well, to as low as $37,000 and as high as $16 million or more.

Cody Crabb (16:28)
Yeah, wow. So what I’m hearing is it’s always worth it to at least do the math.

AJ Lyons (16:35)
Yeah, and we always

offer, we have like a simple calculator page and then sort of a more detailed estimate as well. We always want you to see like, hey, what is the estimated benefit of this report gonna be to me before I make purchase? We always want you to be happy with the product and what you’re gonna receive and just make sure that it makes sense before you actually, you know, proceed with purchase.

Cody Crabb (16:39)
awesome.

Yeah,

yeah, that makes a lot of sense. ⁓ All right, so kind of moving into the next ⁓ part of what I wanted to ask you. So ⁓ in today’s market, you know, ⁓ things are, people kind of are ⁓ worried. People have expressed that to me on the podcast. saying rates are higher, margins are tighter. Did those things affect how we should be thinking about tax strategy in general and especially cost seg or?

does that not really affect it? It’s like, hey, it’s just some extra cash you could get in your pocket.

AJ Lyons (17:25)
Yeah, at the end of the day, like when I’ve talked with some of the other co-owners or just people in the industry, people do cost seg when times are good and they just, you know, want to save that money and not pay their IRS. It also makes sense when, when times are bad and maybe people are thinking about it a bit more, you know, when we’re, we’re in a

a where interest rates are higher and you’re just looking for all of those strategies that you can use to maximize your return on investment.

⁓ But really, cost seg, just regardless, it makes sense to do. Why not keep that money in your pocket rather than paying it to the IRS and either keep it in your pocket or use that to cash flow your next investment and sort of help build your portfolio. So.

I always say that cost seg should never be like the only reason that you’re doing an investment property and it should be the cherry on top.

Don’t let it guide the investment fully. It’s just another tool in your tool belt to use on top of everything else that you’re already doing.

Cody Crabb (18:30)
Yeah, interesting. So, okay, let’s say someone is, they own some rentals, they’re looking, hey, maybe one of my properties might qualify for this. What is the very first step they should take? You said you have a calculator, tell us about that.

AJ Lyons (18:41)
Yeah, so I would say that the first thing is just to look for a depreciation calculator. know, like on our website, we have what we call our simple calculator. That’s going to be about six to eight questions that you fill in, and that’s going to give you the, you know, a more general answer, but a sense of like, Hey, is it going to make sense for this property where, you know, sort of on the chart? Yeah, exactly. ⁓ from there, once you see that, that’s when you can say like, okay, it’s, it’s definitely going to make

Cody Crabb (19:03)
How far should we dig in? Yeah.

AJ Lyons (19:11)
sense, let me dive into this a bit further. ⁓ And that’s when you would go directly to our website, fill out the form that we have for that specific building type, ⁓ and then that form asks, you know, maybe 20 to 30 questions, depending on the building type, you know, it may populate some more depending on some of your answers, you know, like are there site improvements? And you say yes to a pool. Well, then we’re asking is there a pool enclosure and other stuff like that. So the number of questions ranges, but then

Cody Crabb (19:21)
Ahem.

AJ Lyons (19:41)
And that one is going to give you ⁓ a pinpoint even more, hey, this is going to be the benefit that…

spectra see you so

Let me back up little, guess before that, gather the info. ⁓ If you don’t have the info on the property right in front of you, make sure you get that. But it’s all, like I said previously, sort of stuff that you should either know because it’s your property, you’re in it, you’re working on it, you just closed the deal, so you’re really familiar with it. Or it’s something that you can gather from, say, an appraisal or other online sources like realtor.com, zillow.com, et cetera, if you happen to be looking at it before you actually made the purchase, ⁓ like we said.

Cody Crabb (20:19)
Gotcha, okay.

⁓ where do people, if people want to work with you, where do they need to live? Is there a certain location? Are you nationwide? How does it work?

AJ Lyons (20:27)
Nationwide,

we’ve done reports for people that live in Alaska, Hawaii, and then the continental US. So all 50 states we’ve done reports in.

Cody Crabb (20:38)
Awesome,

so yeah, it seems like this might be worthwhile. mean, if you’re looking at tax time, this is a good time to kind of maybe, you’re stressing about taxes a little bit for next year. Yeah, this is a good time to look at this and get it moving now. ⁓ So where ⁓ can our listeners find you online? Connect with you or get more information about Cost Seg and about your company.

AJ Lyons (20:54)
Yeah.

Yeah, totally. So you can reach out directly to me at [email protected] You know, that’s my email address. I’m always there and available to answer any direct questions there. You can obviously go to our website, DIY cost seg.com ⁓ and, you know, look for that estimate tool. And then I’m also on LinkedIn as AJ Lyons. So any of those work and I can even provide, you know, a meeting link where people could schedule a call with me if they wanted to talk about their property.

Cody Crabb (21:32)
Cool, well thanks so much for joining us today AJ. I know our audience got a lot out of this because I certainly learned a couple things. ⁓ If you, as a listener, if you did learn something, ⁓ please go ahead and give us a subscribe, a like, a comment, all the things so you can get notified for the next episodes. AJ, thanks once again and ⁓ listeners, we’ll see you next time.

AJ Lyons (21:54)
Thanks Cody, bye.