How Real Estate Investors Use Cost Segregation to Save Big on Taxes

Bill Smith (00:00)
One of the mistakes I think that’s made is sometimes clients say, I need cost segregation to make my deal work. And I say, if you need cost segregation to make your deal work, that’s a bad deal. The deal needs to work on its own. Cost segregation is a sweetener and it’s an enhancer, but the deal needs to stand on its own two feet or I would suggest not buying it.

Scott Bursey (01:52)
Welcome back to the Real Estate Pros podcast powered by Investor Fuel. I’m your host, Scott Bursey. And today we are firing up the engines with a guest who brings the high octane fuel for your financial freedom. If you’re serious about building generational wealth, you know that saving money is just as important as making it. Our guest, Bill Smith, is the tax strategist behind ELB Consulting, and he’s unlocking substantial federal tax deductions and credits.

for investors every single day. Get ready pros because Bill is about to show us how to pour your profits back into your pipeline by legally shrinking your tax bill. Bill, welcome to the show.

Bill Smith (02:31)
Thanks Scott, I truly appreciate the opportunity to be here. This is a great thing that real estate investors know. Go ahead.

Scott Bursey (02:33)
It is just wonderful to have you here. Absolutely,

and it’s an honor to have you with us today. For our listeners who may not be familiar with your journey, please give us a front row seat and how your career ignited and where you’re pouring your fuel now.

Bill Smith (02:50)
That’s a great question. I’ve been in the real estate services business ⁓ since I got out of college from technology and services. And I landed on cost segregation with ELB about 13 plus years ago. When I was the first American years ago, we had acquired a company that did similar tools after the tax code of 86. That was a big change. And that’s what kind of opened the door for this tax strategy for real estate investors.

That’s how it got here.

Scott Bursey (03:18)
That’s,

that is a nice path. And Bill, what really caught my attention about you was the way that you’ve been able to maximize complex federal programs, you know, like the employee retention credit and the R &D credits, turning potential liabilities into massive cashflow injections for real estate pros. That’s some complex stuff right there.

Bill Smith (03:41)
Yeah, that’s what we do. We focus on really key opportunities for clients to mitigate their tax liability so they can reinvest money into more property, grow the economy, ⁓ and not avoid taxes to buy Porsches, do things to ⁓ grow the economy. Real estate is one of the top components of our economy. It’s important that it stays healthy.

Scott Bursey (04:05)
Bill, let’s drop this thing into overdrive and talk about tax strategies. What is the one strength of the current tax code that real estate pros often overlook?

Bill Smith (05:02)
Well, one of the key things with the one big beautiful bill that passed is the return of 100 % bonus depreciation on real estate. And there’s some things for manufacturing properties and also for just equipment. mean, for a lot of companies use 100 % bonus when they buy a computer or a tractor or a truck, but it’s available for real estate as well. And so, and it’s been made permanent. And so it started back in 2018.

expired, it kind of ran down and it was reinstated in 2020. So that is one of the key things. The best bang for your buck if you’re a real estate investor is the depreciation model and 100 % bonus depreciation to really accelerate those deductions and offset your federal tax liability. In some cases, your state tax liability. ⁓ So again, reinvest and save money and investors in syndications and other opportunities, they want those deductions as well.

Scott Bursey (05:58)
That’s such a powerful point. Bill, what’s the number one weakness in most investors documentation process for claiming deductions or credits?

Bill Smith (06:07)
I’m unpacking that too much, but the biggest thing that investor can do is they just don’t document, you know, improvements or things. So depending on the company, I mean, if you’re a small investor, you’re doing single family homes or you’re doing short term rentals, there’s a whole short term rental strategy to offset taxes if you’re a W-2 employee, because if you’re not, if you are a W-2 employee, you just can’t take depreciation to offset your income.

Unless your salary, your adjusted gross income is $100,000 or less, you can take $25,000. And that scales away up to $150,000. Most investors are making more money than that. But that is an opportunity for investors. But ⁓ when you’re smaller and growing, if you don’t document that, and if you’re audited, which is rare, but if you’re audited, you got to show what you’ve done. ⁓ And so the IRS will come at you hard.

unfortunately, ⁓ but that’s one of the key things is as you said documentation of what you’ve done. ⁓ We’re pretty good at finding things and helping people with that, but as a bigger investors grow or developers, I mean they’ve got you know all the documentation and cost controls kind of recorded.

Scott Bursey (07:22)
Documentation and consistency is essentially currency. If the books aren’t tight, you’re leaving cash on the table for sure. And Bill, beyond cost segregation, what emerging opportunity is delivering the biggest federal tax credits right now?

Bill Smith (07:36)
There are so many that I see I get a compendium of hundreds of things. There’s a lot of energy tax credits. It’s my knock on my door this week and trying to get me to get solar. You know, I’m not trying to sell you anything. You’re solar. If you qualify with sunlight, that’s like, well, that’s crazy. You know, I’m not going to do that. But the state’s paying for it. So there are opportunities for their solar. There’s oil and gas has become really big. But you whatever you get into.

You need to learn it and know the details, not just trust somebody that’s trying to hustle something, or if you saw TikTok or an Instagram, also you think you’re an expert. You need to talk to an expert and get the expert advice. ⁓ But energy tax credits, credits that were so good a few years back for the real estate industry are just, ⁓ they’re waning. They made some changes to the code and it’s basically killed them. So. ⁓

The simplest, I mean, that’s what we do, is the ⁓ cost segregation and then the research and development tax credit, which isn’t necessarily for ⁓ real estate investors, but architects and engineers certainly benefit from that. ⁓ But if you are investing in your building for your plant, for your company, your own user, you might be doing research and development inside. And so we always look to those clients, what are you doing in the building? What else can we do to kind of add to your ⁓

portfolio of tax incentives.

Scott Bursey (09:00)
Now let’s talk cost segregation, what you specialize in. What is some advice that our listeners need to know right now that they can implement tomorrow?

Bill Smith (09:42)
⁓ Well, a couple of key things when you do a cost segregation study, you want to do it preferably in the year you put the building in service, which means the year you buy it. If you do an acquisition and it’s in service, maybe it’s a triple net, it’s good to go, it’s an apartment complex, it’s up and running, but you might buy a vacant building and you might be repurposing that or doing improvements. So you may want to do it depending on your level of ⁓ purposes. It won’t be in service. So we can document all the

components in that building because if you’re going to tear things out as you improve it say you’re something ⁓

an office building to multifamily. You’re take out a lot of stuff. Well, you paid for a lot of that stuff you take out. So then you can do what’s called partial asset disposition. You can expense those assets that you’re throwing in the dumpster and haul into the landfill. Most people just throw them in the landfill and off they go. Well, that’s an expense. And expenses are really better than depreciation. Ideal depreciation, but expenses are better. They really can’t. If you can expense it, you want to expense it. But it’s gotta align with the tax code.

⁓ So that’s one thing that you want to do and then you may put it in service in a year or two with depending on the construction I have clients that buy old warehouses or old empty Kmart’s or something like that and they’re converting to self storage so that takes some time. Those are empty shelves and not as much disposition but it might take a year or two to get that done and so ⁓ it might go in service later because it’s really once you start collecting rent

it’s considered in service or you get a certificate of occupancy. That’s when you would do that. Or even in a single family residential, if you’re doing rental homes and you don’t have it ready yet, it might fall to a different tax year than when you buy it. You buy it in December, it’s not ready until the next year. It will be impacted that year, depending on kind of, what do call, permitted purpose. There’s a bunch of tax code stuff that’s important. But I talk to clients about that. What are their goals? What are you doing?

what’s important, but getting it done early is always important for several reasons.

Scott Bursey (11:46)
Bill, that is pure fire for our listeners. Now keeping in mind that your expertise is in cost segregation, what should our pros do to immediately, looking to, let’s say close a new commercial deal to maximize tax benefits?

Bill Smith (12:02)
So, I don’t know what’s your typical client. I mean, they’re probably all over the board from residential to commercial, but I have a lot of clients that when they go under contract, they request a proposal from me, a cost segway, because I have a lot of repeat clients, doing this for a long time. So they get an idea of the tax benefit they’re going to be able to pass through on the K-1s in year one. Because most investors, if you’re bringing investors into your deal,

They’re looking for those losses on their K1. They want a good investment deal.

One of the mistakes I think that’s made is sometimes clients say, I need cost segregation to make my deal work. And I say, if you need cost segregation to make your deal work, that’s a bad deal. The deal needs to work on its own. Cost segregation is a sweetener and it’s an enhancer, but the deal needs to stand on its own two feet or I would suggest not buying it.

I mean, I’ll do the cost seg, whatever.

Getting it done early to then let investors know kind of what the projection might be is very important. And then once you close the deal, then we can get started on the cost segregation study and get that done right away. Then if improvements come down the road, we can adjust the improvements because improvements are always done separately. A cost segregation is done as an acquisition, PPA, purchase price acquisition, as it’s bought. Improvements, even if the same year, whenever, before you go in service.

They’re separate for IRS. You’ve got to identify those because as I mentioned before, you might have disposition and abandonment opportunity to expense. And if you don’t, you would have what’s called phantom assets in your building. And so you want to be able to do that.

Scott Bursey (13:37)
Bill, if I’m hearing you correctly, the deal must be stable. Immediate action gets immediate results. That’s why you bring on elite guests like you to explain that. Thank you so much for that breakdown. And Bill, you’ve given us so much value already, but it’s time for the money question, where you supply the high octane fuel. Many of our pros are scaling quickly and shifting from residential to commercial, or simply growing their portfolios rapidly.

What is the most sophisticated federal tax deduction or credit strategy that a successful real estate investor should be implementing right now to unlock multi six figure savings?

Bill Smith (14:57)
Well, know, ⁓ cost segregation, that’s my focus, but that’s the one. If you’re in real estate, that is the best bang for your buck, gives you the most opportunity to offset federal taxes and save money to, ⁓ again, reinvest in more. So, a quick example. So you’re buying a $10 million property.

deduct land allocation as a land allocation. You know, we estimate 20 % depending on markets. Sometimes it’s really high in New York City and Beverly Hills. They have a lot very proud of their land. So there’s a ratio there, but let’s say it’s 20%. And so that’s $8 million on your books that you are your depreciable basis. And if it’s a multifamily, we’re liable to get anywhere between 25 and 35 % of that to reclassify into five, seven, 15 year property.

Anything less than 20 year property qualifies for 100 % bonus depreciation. And many people don’t actually know what that is. So I’ll explain that. So of that, you know, 8 million, let’s say 25 % qualifies for, you know, short life property. And that’s conservative, but let’s say it because easy math, that’s $2 million. There’s a $2 million deduction right there in five and 15 year property. And so

That goes straight against the business. And let’s say they made a half a million dollars in net income that year, half a million dollars, two million, they’re going to show a loss of 1.5 million. However, they’ve got a cash of a half a million and that loss is going to carry forward. It’s going to get passed through on K1s. So the investors get that loss to offset their taxes because they’re trying to offset their tax liability.

So it’s really important to understand kind of the mechanics and also the company you’re working with and the type of studies that they would employ because methodology makes a huge difference in the quality, ⁓ in the results, and in the unlikely event of an audit, in the protections you’re going to have.

Scott Bursey (16:55)
This has been an absolute game changer for our listeners. The depth of your knowledge on tax deductions and credits is exactly the fuel our listeners needed today. You’ve given us so much great advice. Is there any additional advice you can give our listeners on cost segregation?

Bill Smith (17:12)
Well, you know, one of the things is, you know, choose your partner, right. Look at their methodology. There’s a lot of people out there doing it and a lot of people doing it wrong or poorly. ⁓ and so don’t shop on price shop on methodology and somebody who’s going to stand behind it. ⁓ and also, you know, know it, how it applies to residential rentals, the short-term on a loophole.

Then commercial if you’re listeners I think most of them might qualify as reps real estate professional status because their world is real estate So they can offset their income with this depreciation or their spouse’s income so many of my clients I’ve got a high-earning doctor lawyer Consultant, know somewhere and then they’re making over a million bucks a year and they have a huge tax liability the spouse

Kids might be in school, they’re going on, they start buying real estate and if they focus 750 hours on what rep status people should know, and 151 % of their business working hours might be kids, then that deduction can offset that K-1, that ordinary income. So that’s what so many people are driving is how can we offset that ordinary income.

If you’re just in real estate, you’re going to offset any income, any passive or ordinary income. And the short-term loophole is the one thing that people can look up that if they want to, I don’t have time to be real estate professional, but I like to vacation. I like short-term rentals. I stay in Airbnb as my travel. You can invest in one of those and do it right and only spend a hundred hours per year versus $750. And you can use that to offset.

your W-2 income and so many people are doing that these days. I get so many people that have employed that strategy because they want to reduce their tax liability so they can buy more properties because every time you save 25 or more percent on those, that’s your down payment for your next property because that’s money you’re not paying the IRS. If it’s always a tax deduction, it’s really a cash flow strategy and the IRS tells you that as well. So maybe I went over on that question but those are really important things to consider.

as an investor.

Scott Bursey (19:20)
Well, this has been an absolute master class on cost segregation. For those of our listeners that want to ⁓ the conversation moving or collaborate with you, what’s the best way for them to plug into your pipeline and reach you directly?

Bill Smith (19:33)
Well you can call me on my cell phone, I use that as my office phone, it’s 480-747-5547, again that’s 480-747-5547, that’s an Arizona number but I live in Virginia. And then my email is Bill, B-I-L-L, at ELBCostSeg.com, very simple, [email protected] Happy to answer questions, talk about strategy, look at portfolios, people say,

Why did I never do this before? Why don’t my CPA tell me about this? It’s not their world. CPAs, you’re like their world. They are general practitioners like your family doctor and they find a lump, they find something that’s like, hmm, they see it to the expert. We’re the expert. So happy to talk about that and then work with your CPA as well.

Scott Bursey (20:16)
Thank you for joining us today, Bill.

Bill Smith (20:17)
All right, I appreciate it. Thank you for having us. Happy me.

Scott Bursey (20:20)
and

to our listeners, we appreciate you. If you got value from today’s episode, please subscribe. We’ll be filling your tanks with a lineup of elite guests, just like Bill Smith, who are accelerating and setting the pace for the rest of the industry. Until next time, keep your standards high and your vision clear. We’ll see you in the next episode, everyone.