Maybe I just didn’t deduct things properly because I was doing it on my own or whatever. Could we come in at year 2 or year 7 and right the ship, or is it like a lost opportunity at that point?
Oh, it’s not a lost opportunity. That’s why we come in, we have you do a Cost Segregation study. On a residential building, it’s not like going into a multi-million dollar building and costing all this money. You get it done, we file our certain form, and you get to pick up all that depreciation that you should have taken over the last 7 years, and you get it all in one shot. It’s called planning. They guy’s not necessarily an asshole, he’s putting the right numbers in the right boxes, and he’s doing everything, but he’s just not planning, and typically there’s not a lot of communication and it just takes more communication and a little bit more time to do that kind of stuff, but it turns into dollars.
Let’s say that we have a residential property, where you’re saying we could depreciate it over 27 years, and I’ve been doing that for 5 years. Maybe I took just a round number $1,000 off of my income each year for 5 years. You’re saying we could go in, we could do the Cost Segregation study, we could figure out what’s been left on the table for the past 5 years, just saying maybe it’s an extra $3,000. So this year I can take my normal $1,000 plus that extra $3,000?
Well, this year you would take whatever you should have taken in, let’s just call it year 7, and then all that missed depreciation that you should have taken, you pick all that up in that same year.
Okay. Andrew, you haven’t even had your places for one year yet though, right?
Yeah, maybe one of them is like a year and a month at this point. Okay, so here’s the thing. You’re saying this Cost Segregation study, I’m in New York or almost New York or across the river from New York, Cody, you’re in New York, so what do I have to do? Pay to fly you out there so you can …
No, there’s actually a company that we deal with that does the study, because we’re not trained in that. It’s actually reasonably priced. They put you through a series of questions, and there’s a lot of information you have to give them and they put the study together, and they stand behind the study.
What does reasonably priced mean?
Let’s just say a residential building, less than $1,000.
Okay, so if I have some standalone thing in Georgia, and it will be like a $1,000 and they’ll go into every room and they’ll find screws and all this-
No, for $1,000 they’re not going to fly out to your house in Georgia, but they have the software and a questionnaire for you to go through, and they have algorithms, and it works very good. We’ve seen it work. Based on that, they will give you a Cost Segregation study that can stand up to an IRS audit.
Okay, so let me make this even more difficult for you.
They’re like basically models that allow them to do this without actually having to look at the physical property.
Well, yeah, because you’re looking at it and you’re putting in the information that they need.
Oh, okay, cool. Well, Andrew, you can’t do that.
Well, here’s the thing. That sounds great, ’cause I just have to fill out this questionnaire, but the property’s in Georgia and what if I’ve never seen it before? I’ve seen the pictures of it on the Internet.
I think you could handle it.
Send the tax guy with iPhone.
Yeah, okay. All right, fair enough. I got you.
Kind of like we’re having this conversation right now. We’re in three different places.
That’s true, you could just have somebody with a Skype and a phone and walk it around the house. My question right now is if it’s $1,000, how do you do the math to make sure it’s going to pay off?
Well, usually what we do is we can pop in some numbers and we can get a general idea of what it’s going to be.
Before you pay?
Really the people that you’re hiring to do this, it’s kind of a formality and you already have an educated guess of what you’re going to be able to save by doing this?
Exactly. They’ve done it many, many times, so a standard building, they have a general idea.
Okay. Explain this to me. We’re depreciating faster, but we’re still depreciating the same amount over the longterm, right? Where do the savings lie in that structure?
Upfront, so you get more deductions upfront and less on the backend. Let’s just say you take that money that you save in year 1 through 5, and you put it in the bank. When you get to year 25, you’ll have a lot more money than you did if you didn’t take that money.
Really, the concept here is lower your income now by taking a higher depreciation, invest the money you save, and you’re investing more sooner so you’ll have better compound returns over the long run, which should offset the fewer amount of dollars you can depreciate later on.
Right, it’s basically you’re taking that money that you would not have had and you’re using it, and typically people in real estate buy more real estate, so they use that cash flow to do other things.
Or if you want to exit a property, this could count against the profits and stuff, so you don’t have to wait 30 years to …
When you sell a property, you have to recapture that depreciation, okay?
What does that mean?
When you sell a property and you’ve depreciated that property, let’s just say I pay $100,000 for a building, and every year, let’s make it simple, I depreciate $10,000. After 5 years, my basis in that property is $50,000. If I sell it for 150, now I have $100,000 gain instead of a 50, ’cause I depreciated it and I took that expense.
Essentially, you should ideally not sell rental properties until like 30 years or something.
Well, you’ll have depreciation down the road, but you have to just kind of look at the economics of the deal, does it make sense.
If we were working together, I’d be like, “Cody, can I sell this,” and you’d run some analysis, and you’d tell me the cost essentially.
Correct, we’d be able to figure, okay, this is what the tax liability’s going to be and then maybe you’re going to do a 1031 Exchange so there is no tax liability.
What is that?
Yeah, what’s that?
A 1031 is a tax-free exchange of, we’ll call it, real estate. I sell Building A, I have $150,000 profit, but I don’t want to pay tax on that because I’m buying Building B. So I take all that money and I’m rolling it into Building B, so what is use is I use an independent person, which is like an agent. I never get the money. I have approximately 45 days from the time I sell the building to identify three other buildings that I want to buy, and I have to close on one of those buildings in six months, and I don’t pay tax on the sale.
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