Find out exactly when a cost segregation study pays off and when to skip it, using a simple land-to-building allocation test.
[00:00] Why cost seg is NOT always a no-brainer
[00:19] Land vs. building allocation: the first filter
[00:43] Location matters: coastal vs. high desert example
[02:19] Running the numbers on a $1M property
[02:49] Applying 25% bonus depreciation to the Santa Monica example
[03:09] Cost seg as tax deferral, not permanent savings
[03:37] Residential (27.5 yr) vs. commercial (39 yr) property impact
[04:12] Depreciation recapture explained simply
[05:08] Why 1031 exchanges make cost seg a long-term win
[05:30] When Advise RE recommends skipping the study entirely
[05:42] Why large acquisitions tip the ROI in favor of cost seg
In this video, the team at Advise RE breaks down the decision framework every real estate investor needs before spending $5,000 to $6,000 on a cost seg vendor. The answer hinges on your land-to-building allocation ratio, your property type, and how you plan to exit. 🏠
TRANSCRIPT:
[00:00] We are back. Stefan Morris here with advisory. Today, we're gonna talk a bit more about cost segregation studies. Now we've beaten cost segregation studies to death here on this page, but I do wanna talk about one particular area, which is when to do it versus when not to do it. Because I will honestly say cost segregation studies are not always the best idea. [00:19] It's gonna depend on the economic outcome. Let's dive into the specifics of how this works out mechanically. Let's talk about when it's a good time to do a cost segregation study. You just bought a property for a million dollars, and you realize after doing a land building allocation, you always have to do that. Very very first thing you do when you're buying this property is figure out what portion of it is land, what portion of it is building. [00:43] And how do you figure that out? It's gonna be facts and circumstances. So the thing I always tell all my clients is you gotta look at where the property is located and why did you buy it? Did you buy it for the location or did you buy it for the building? And the best example I can give is, let's take a coastal property in let's do Santa Monica, for example, which is prime real estate out here in the LA Metro Area, and you bought a property for a million dollars versus a property out in the middle of the High Desert for a million dollars as well. [01:13] In the absence of any other information, I'm not gonna tell you any more facts, I think it's reasonable to conclude that the location on the coast, especially near the beach, is gonna be superior to being out in the desert. Not knocking you guys if you love living in the desert, but simply saying that in terms of the laws of supply and demand, the demand is really more towards buying a property that's has an ocean view than one that's out in the middle of the desert where it's very hot. So we can infer from that situation that if we're doing an allocation, a lot more is gonna be weighted towards the land in the Santa Monica play. And in the desert, we know we're probably buying an amazing property for a million dollars. It might be a mansion sitting on a lot of desert land because the land's very cheap out there. [01:52] Whereas in Santa Monica, you're probably getting a small sliver of land and an old home that's about a 100 years old for the same price. So we know we're buying the location there. That's very important because then when we're thinking about doing a cost segregation study, the million dollar property in Santa Monica might be, oh, don't know, $800,000 allocated to land, 200,000 to the building. Building's just not worth that much. Whereas in the High Desert, it might be the reverse. [02:19] It might be 200,000 for the land or less, and $800,000 for the building. So now with this in mind, which one's gonna give you the best cost segregation outcome? The one in the desert. Right? Because if we're gonna use this rule of roughly around 25, 30% of the building is going to be reallocated to the shorter lived assets that are eligible for bonus depreciation, we're gonna get a very large deduction in the desert property and a very small deduction in the Santa Monica property. [02:49] So let's assume that 25% of the Santa Monica property is eligible for bonus. That would be $50,000 of bonus depreciation. The tax impact of that might be somewhere around $1,314,000 dollars. If it costed you 5 or $6,000 to do a cost segregation study to get that outcome, it's not that interesting. Right? [03:09] Because the cost segregation study does not give you a permanent tax benefit. It's just an immediate tax deduction, which will be paid later when you sell the property. We'll dive into those mechanics shortly. Whereas in the High Desert property, we're talking about a $203,100,000 dollar tax deduction, fantastic outcome, and that would alone be where very much worth the $5,000 cost segregation payment that you're making to generate that study. When is it even more worth it? [03:37] It's also gonna depend on the property use. A property that has a twenty seven and a half year life for residential use is gonna get a little bit less benefit out of cost segregation study than one that has a thirty nine year use, like hotels, office, retail, all that good stuff. So even with the same purchase price, we're also gonna look at what's the actual benefit in terms of dollars today versus what I would be able to recuperate because you're gonna get this depreciate depreciation anyway. Right? And so you're gonna have to figure out whether or not it's gonna be useful today versus just waiting it out for a few years to eventually get it. [04:12] Let's go back to the recapture discussion. So as I mentioned, a cost segregation study is not a permanent tax savings. It is a tax deferral strategy. You were gonna get that depreciation. It was just gonna be over a longer period of time. [04:26] And the reason why we like cost segregation studies because we want the deduction today so we have the money today so we can go out and reinvest And honestly, the name of the game and most of tax planning and strategy is around deferral. It's not around permanent, absolute, you will not pay taxes kind of kind of strategies. So with that in mind, just remember that one day when you sell it, all that depreciation that you took is gonna come back in the form of a gain. So don't think that, hey, I'm gonna buy this property, generate a $500,000 depreciation deduction, and I'll turn around and flip it and sell it the next year, and then I'll go buy another property. It's not gonna work because that $500,000 is gonna come back to you, albeit in the form of a lower tax rate, 25% for the section twelve fifty rate. [05:08] However, it's still coming back to you. You're still gonna be paying taxes on it. This is a much better strategy if you're buying, holding, and eventually ten thirty one, selling it. So that way, continue to keep that deferral going without picking up the taxable income once more. So in conclusion, what we're talking about here is that cost segregation studies are generally good, but they're not an automatic no brainer. [05:30] There are a lot of times where I'm having discussions with my clients, and I'm telling them, hey. You know, depends on where you buy it. I might tell you no. It's not really worth it to to generate the study. You might just wanna take the normal depreciation and move on. [05:42] For very large acquisitions, very large purchases, they start to make a lot more sense. We generally prescribe those almost always. And even if you can't use all the losses that year, assuming you meet a real estate professional, then you can always carry it forward through net operating loss carry forwards. So we absolutely love it. If you wanna know more about it or if you're just trying to understand whether or not the cost segregation study is right for properties that you own or you're considering engaging a cost seg vendor on, then feel free to reach out to us right here, we'll and be more than happy to assist you in your evaluation. [06:13] Thanks so much for watching. So make sure to like and subscribe to our channel for all the content related to real estate investment and tax saving strategies.