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Senior Housing Investors
The Power of Cost Segregation in Real Estate with Chris Streit
Unlock the secret to maximizing your real estate investment returns with expert insights from Chris Streit, CEO of Cost Segregation Authority. Discover how the strategic use of cost segregation can elevate your cash flow by accelerating depreciation on your properties. Special focus is given to senior living facilities, where reclassifying building components into shorter depreciation categories opens the door to immediate liquidity and further investment opportunities. Tune in to learn about the powerful tax incentives available, such as the 179D energy efficiency deduction, which can significantly amplify your financial returns.
Navigate the complexities of cost segregation and depreciation with us as we debunk myths like its restriction to new or improved properties. Chris sheds light on the broad applicability of these strategies across various real estate types and discusses the evolving landscape, highlighting reduced costs and increased accessibility of cost segregation studies. We dive into the critical balancing act between achieving immediate tax savings and managing future depreciation recapture liabilities, showing you how to execute a thorough cost-benefit analysis for smarter financial decisions.
Finally, gain a deep understanding of the intricacies involved in managing client expectations around recapture, particularly when properties are sold sooner than expected. We provide guidance on evaluating the economic viability of cost segregation for different properties, emphasizing the importance of holding periods and financial strategy. Learn how recent legislative changes, like the Inflation Reduction Act, present new opportunities and challenges in maximizing tax benefits through energy efficiency incentives. This episode is a treasure trove of practical advice, ready to transform your approach to real estate investment and taxation.
For really anybody who has a real estate investment property, something that generates income they benefit from cost segregation. But somebody in the senior living space has even more opportunity because somebody in this space is typically investing a lot in improvements in a property. There's a lot of stuff inside what you would call the building envelope. One of the biggest impacts that cost segregation provides somebody in that space is an improvement to cash flow through accelerated depreciation. So your living facility takes an asset that can be depreciated over the course of 39 years and taking a small portion every year and rapidly taking improvements and moving them into five, seven and 15-year categories all at once and taking the benefit of that depreciation now. So that way the money is available to be used now as an investor. You can use it to make further improvements on the building or to go buy another property.
Speaker 2:Welcome to the Senior Housing Investors Podcast. If you are an owner operator, investor, developer or buyer of senior housing, you've come to the right place. The best way to stay connected with us is to sign up for our weekly newsletter at havenseniorinvestmentscom. This podcast doesn't exist without you, our community. Thank you for listening and reach out to us anytime.
Speaker 3:Welcome back everyone. Today, our host, john Haber, is speaking with the CEO of Cost Segregation Authority, chris Street. Cost segregation services are one of the most effective ways to free up liquidity and improve cash flow. If you own a qualifying commercial or residential rental property and you're currently paying taxes, cost segregation is likely to provide significant economic benefit for you. Listen in to hear how Cost Segregation Authority is increasing cash flows for their customers. John.
Speaker 4:Elsie. Thank you very much, Chris. Welcome to the show. Thank you, it's good to have you on and good to get to know you at the last show we were at, and so tell us a little bit about yourself and your company and we'll go from there.
Speaker 1:Yeah, sure so, chris Stried, thank you for having me on, john, it's definitely a pleasure getting to meet you. I work at a firm Cost Segregation Authority. We pretty much just do one thing, which is cost segregation, but also energy efficiency, tax credit, all tied to real estate, real estate investments and maximizing tax incentives for those people who do invest in real estate and for those people who develop real estate.
Speaker 4:Awesome, and how does that benefit the senior living space?
Speaker 1:Well, you know. So interesting enough, really, anybody who has a real estate investment property, something that generates income, they benefit from cost segregation. But somebody in the senior living space has even more opportunity because somebody in this space is typically investing a lot in improvements in a property. There's a lot of stuff inside what you would call the building envelope. So one of the biggest impacts that cost segregation provides somebody in that space with that type of focus and investment strategy is an improvement to cash flow through accelerated depreciation.
Speaker 1:Cost segregation in particular is a way of taking something that in the case, so your oiling facility takes an asset that can be depreciated over the course of 39 years and taking a small portion every year and rapidly taking improvements and moving them into five, seven and 15-year categories all at once and taking the benefit of that depreciation now. So that way the money is available to be used now. As an investor, you can use it to make further improvements on the building or to go buy another property. It's really one of the key ways to generate additional cashflow. And those people who develop these types of facilities, in addition to cost segregation, they have a lot of opportunity from the government to capitalize on something called 179D, which is an energy efficiency deduction which is based on what you put into the envelope of the building think HVAC, think walls. It's a little bit more complicated to get, but that's why we're here, and it does provide the same benefit.
Speaker 4:Have you ever worked with CPACE and does CPACE play a part in looking at the cost segregation study as a part of how much funding you can get from CPACE?
Speaker 1:So we have not, but that typically probably something that happens before we get involved. We're typically post-close, except on the new home builder side of things, where you get energy credit for a door. But no, we have not worked directly with them. Okay, cool.
Speaker 4:So what are the key components of a comprehensive cost segregation study and how do they contribute to maximizing tax benefits?
Speaker 1:So the key components to a cost segregation study I mean I can say it three times it's precision, precision, precision. But there are a lot of things that go into precision. See, the challenge with cost segregation in the cost segregation industry is where I'm sitting in this office in Dallas, texas, is I could probably look at a property pretty easily, really quick, and just determine that there's X number of dollars available and validate it in some way and go through a few motions to get it done and find a pretty decent benefit for not too much of an expense for an investor. But the key thing to doing it right is having a high degree of precision and measurement and having a lot of the data down to the inch of what's inside the building, almost treating it like an engineering or construction product. What's interesting about cost segregation in our business in particular? It's an intersection of accounting and construction, so you could have somebody reverse bet a job. That's the number one. Most important thing is that you have high quality detail on the improvements that were made to a building, even if it's not something that's new construction. If it's something that already existed, somebody bought it. That's the number one piece in doing the estimation with as much precision with the data available that you have From there, it's being able to audit it, make sure it does stand up to the IRS criteria.
Speaker 1:We use a 12-step system based off of the IRS audit guide. Basically, when you have the volume of auditors that you have going and being attached to multiple or being assigned to multiple different types of taxpayers, those auditors need education for different niche parts of the tax law. What we built is basically an education platform whenever the audit does come up, to be able to give them. Here's all the detail that you need. Here's the case law behind each one of these assets and their useful life. Now you can take this and make your determination relatively easily. So precision and alignment with the IRS audit guide are two of the biggest things that are out there needed, because the precision lets you be aggressive and the backing of the IRS audit and doing everything in accordance with that gives you the confidence of knowing you're doing it correctly and you're not going to hurt your client Cool.
Speaker 4:So I'm curious, chris how has the phase out of bonus depreciation and that the reduction to 60% in 2024 impacted the benefits of a cost segregation study?
Speaker 1:Just initially only having that percentage of bonus for the current year and years prior, as it's been slowly being phased out. It does impact the year one benefit those assets that are identified for five year, seven year and 15 year. They are getting those actual lives and a smaller percentage can be taken year one, so it does have a cashflow impact. There's been rare instances where I've seen that it still doesn't make a ton of sense to do it. I think what people are dealing with now is since you know bonus is likely coming back in the wake of the election. People for the last six to seven months have known that bonus is something that might be coming back and they've been waiting to see because you know 60% is still great. The only challenge is it's not as great as 100%. So when you have the possibility of 100% it makes you sit there and wait. So still been very viable and been material for a lot of clients. It would be better if it was 100%, but it just was not.
Speaker 4:So has that impacted how many studies you do People are holding off, or do they do the studies and then hold off on taking the depreciation I've?
Speaker 1:seen both the first piece people probably are also. You know it's been a little bit in an election year as well, as you know interest rates. There has been some uncertainty. That's just one of the pieces. What we've done for a lot of our clients to add certainty. Where there is uncertainty is we would do the study now, because when you do a good cost segregation study, you should actually do a site visit. I talked a lot about precision, but the site visit is key and there's a limited number of resources in all accounting and tax. That's not untrue with cost segregation as well. So what we've done for people who want to see what happens with bonus, to see if it comes back, is we engaged to do the study. We did it at the current rate of bonus depreciation and if it passes for the next tax year we will redo the redo for free. That way people have it done. It's already in the bag and if we need to add bonus, it's a simple calculation.
Speaker 4:Well, that works, and so you and I have spoken before and I related instance where someone I know had said that why do cost segregation if you're not doing improvements? And there was a misconception, based on what I know now, in regards to cost segregation. What are the most common misconceptions that the market has or owners of real estate have?
Speaker 1:That's a very common viewpoint too, because the reality is there are a good amount of misconceptions and they started with when cost segregation was currently first thrown out into the market. It was a completely different offering First. It was really expensive to get done, there was a high materiality threshold on the building and there were certain elements that made it more restrictive. So maybe all the improvements could be considered, especially if you already bought an existing building and you were remodeling. Take that to today, where all the misconceptions exist because they aren't real, but they're real because they were something that somebody experienced years ago and doesn't realize that it changed. So two one of them is yeah, I only can do this on new property. I can only do it on things that I'm actually buying, which is not true. The IRS has an engineering method which allows you to estimate improvements that were made prior to you buying it, to truly segregate it out versus one property. Another one is that it can be extremely expensive.
Speaker 1:I'm always blown away by cost segregation is typically the ROI and a cost segregation expenses usually at a minimum, 10 to one the return and the tax savings that comes with it, and just because of the course of time and with COVID, it's been able to be, you know, be done remotely, to be done in a way that you know requires much less time investment, much less people investment, much less travel, which is great for taxpayers because they can get the benefit.
Speaker 1:The other one was that it really only applies to industrial or complex properties, which is also not true. Our business does thousands of single family home properties that are just rental properties for somebody. Really, anything in real estate is something that's out there that is an investment, as long as it's not a $50,000 home or something like that, where it might not make sense, where it's going to make up for the fee. But usually, you know, our floor is somewhere around $150,000, $200,000 in basis and anything above that. That's a real estate investment property that generates income. It's eligible for cost tech. I think a lot of people look past that Awesome.
Speaker 4:So I'm curious, chris, and that is how can property owners effectively balance the immediate tax savings from cost segregation with potential future depreciation, recapture liabilities?
Speaker 1:So recapture is something and I would have included that in one of my misconceptions as well, because recapture on its own sounds terrifying, like the word capture now I'm going to redo it again so I think it already brings with it this fear associated with it. I think it's not necessarily warranted, because depreciation even if you don't do a cost segregation, there's an element of it's similar to recapture. The output is the same when you do sell a property, the depreciation that you've already taken you can't keep depreciation forever essentially, so outweigh the benefits. What you're really looking at here in a deduction for a cost segregation is you are getting through this instrument, getting cash. Currently today, and those of you who don't know what recapture is, as you own the asset year after year, part of that actually does depreciate and the asset goes away and it reduces your basis. If you sell that property before that asset is fully depreciated, then you have to basically give that depreciation back. What I look at in that case is to say how do you balance it out? Well, it's a simple cost benefit analysis. Or, for those of us who want to go back to our finance classes which I'd really have to wake up and have an extra set of coffee on is look at it as a financial instrument of net present value. How much money do I have now? What's the current interest rate? What's the expense to do it? What's the NPV on it?
Speaker 1:Even if you hold a property for a year your five-year assets you depreciate it. You got 20% of it. Your seven-year, you got one-seventh. Your 15-year, you got one-fifteenth. As you go to sell that property, if you took accelerated depreciation on those assets, you got all that money today. You got it right now and as an investor that's very valuable.
Speaker 1:Now the key thing in recapture is you have to pay penalty, you have to pay interest. Now I just have to give back the depreciation I did not take. So even in that state you still get a little bit of depreciation. But the biggest value you got is for a very nominal fee to do the cost segregation. You effectively got a loan and somebody paid you for the loan versus you paying for the loan. You got to use that for something else. That's why when I look at recapture, I almost look at it like a 401k. It's almost deferring the tax you have to pay and you're using depreciation as a means to not pay it now. And for that reason, I think a lot of people look at it and say recapture, it's terrifying. No-transcript capital.
Speaker 4:I agree, but many CPAs have no idea about what they are talking about as it relates to cost segregation. How do we speak to the CPAs that are listening to this podcast regarding cost segregation and how to communicate that to their clients that are coming to them for advice? Do they take classes? Do they come to you? What would you recommend CPAs do?
Speaker 1:So CPAs, I think, have one of the hardest jobs in the world. That's why it's hard to increase the talent pool of CPAs out there, because it's so stinking hard. I mean, a lot of us can't get through it in college just to get to the point where we can even take a CPA exam. And then you know, the goalpost is always moving up, the laws are always changing. I get it. It's challenging. You know. Recapture is one of those things that I think when a CPA looks at it, they're trying to manage expectations of a customer. And so when they look at something in the near term and somebody tells them you get a benefit of X number 100,000 or X number a million dollars, and the full story is if you plan on selling this property in a year or two, then you're not going to get all of that. That's not the full benefit. But I would recommend CPAs. I don't think they need to take class. I would love to be a resource to any CPAs. We support over 11,000 CPAs at Cost Segregation Authority. We're the back office for cost segregation, so I think we could definitely help if anybody has those questions. But what I always like to do is have a conversation to figure out, not just. We have to move away from recapture is bad and recapture is good.
Speaker 1:The reality is recapture is recapture and I want to note for individual CPA why are you concerned about it for this particular client? And they might have a very good reason, because everybody's tax situation is completely different. But to dismiss it unilaterally as something that you should or should not worry about is wrong. So what I like to do, and this is we do CPEs where we're certified to do CPEs by NASBA, and this is one of the biggest things we always talk about. Whenever I just come up with a CPA, I ask them what are you concerned about it? And they typically describe why. Then I ask them to tell me what recapture is, and I think when you really define recapture, write down the words.
Speaker 1:Tell me what recapture is and I think when you really define recapture, write down the words it is the recapturing of a tax benefit you got for depreciation that you took. You ultimately did not see all the way through. That is money, up front money at the beginning. I would encourage them just to reframe it. But also, please do feel free to reach out to me as a resource and you will see I won't try to jam a cost stick down your throat, but I will try to help define the situation. It might be, here's the benefit. But if there is a recapture, you need to look at as a not a permanent benefit. It's a benefit that you get now and if you're an investor, they're going to be very happy about that and thank you as their CPA that you didn't shove it away when they could have had money right there.
Speaker 4:I appreciate that explanation. And so, when individuals are thinking about doing cost segregation, when would you, or the individuals that work for you, tell a potential customer that, no, it just does not make sense? What are those situations?
Speaker 1:So the situations where it wouldn't make too much sense is one of the ones I mentioned earlier if the cost of the property is just too low. Or if the cost of the property is just too low, if somebody, let's say they got it through an estate or something like that, who knows, or on an auction block and they paid $50,000 for a rental property, the amount of depreciation you're going to get with the tax benefit it's going to eat into it. If the fee is going to make it not make a lot of sense. I think $180,000, $200,000 around there is where you start to say, okay, if I've paid this amount for a property, then I can use that from a standpoint basis to depreciate and it will make economic sense for me to pay somebody to do that. Otherwise it would not.
Speaker 1:The other one really boils down to if you're going to be flipping a property as well. If it's something that you want to buy and sell three, four or five months from now, I don't really think that's a good idea. To do a cost segregation on, take this accelerated depreciation only to sell it in the same tax years a few months later, that doesn't make too much sense either. And of course, for those who haven't had too much experience with cost segregation, you obviously can't use this as your main source of living. If you live in a property you can't cost segregate it. But for the most part those are some of the biggest ones that I think I would say rule out. The rest of them, I think it's at least looking into to see if there is opportunity.
Speaker 4:I'm curious, chris, because this just came up to my head, is how long would an investment group or investors or owners hold a property that they've done cost segregation on? What would be the maximum benefit of a hold period? What would that hold period be?
Speaker 1:bonuses involved. Because, as you can imagine, if you take all the depreciation in year one, it begins to completely flip in the latter years. Where I see the biggest benefit is really around that three to five-year mark. And the reason why is when you do a cost segregation you've heard me say now a couple of times five years, seven years, 15 years those five-year assets are where you get the most value from, because number one, it's a lot more accelerated depreciation, but there's typically a lot of things it's.
Speaker 1:One of the biggest things we're looking for is let's find five-year assets Usually it's somewhere in the range of 30% to 40% that we can use and reclassify as a five-year asset. When doing that, if you are holding a period for three to five years, you're getting the bulk of that depreciation without having to worry about recapture on those five-year assets. So if you are an investor and you're thinking, okay, what about my whole period? It really would be fitting with that three to five year where you can get a pretty big benefit, fully depreciate those five-year assets and only have some recapture on the 715, where you can get your largest bang for your buck.
Speaker 4:So what would be an example of a cost segregation study that you've done this year, that the ownership group or the owner was extremely pleased with the outcome of it?
Speaker 1:Sure, extremely pleased with the outcome of it. Sure, so it was this one's interesting because it's there was a lot of improvements on this one. One of the things people don't realize is, even if they don't own the actual physical space. Take a restaurant, for instance, and you have this restaurateur who finds their space and they just load the place with improvements, they put in tons of plumbing, they put in, you know, everything it takes to run a restaurant with improvements. They put in tons of plumbing, they put in everything it takes to run a restaurant stovetops and all of that. In this one case, going into the detail of each one of these, going through the receipts, going through the invoices, we're able to identify in this restaurant, because all the plumbing and everything that went into it, that was attached, the material that was necessary for the use of the business, it was around 40% and these were not small improvements and it was four restaurants that they just bought. I mean it was total four and a half million for each, so 16 million. You take that 40%, you can see found $4 million in accelerated depreciation. Also, what was happening is interesting.
Speaker 1:The last four or five years of COVID and everything. I think we've all seen this as there's been a. There was obviously a major dip in hospitality, then a boom in hospitality and a lot of our clients are these large hospitality resorts who are constantly changing things, making improvements. You know we have one client who owns multiple of these resorts who had to invest a lot in improvements this year that are just kind of like recurring things, like changing the outside veneer of the business and those pieces $8 million this property here, $10 million in accelerated appreciation in this property here. There was a large, large amount of those and the others would be, and I only asked for one. But I've touched a good amount.
Speaker 1:Some of the most recent ones is some large accounting firms think like big four type folks. There's a cost segregation element to their business. It's not the primary element of what they do. We've recently done what you call a come from behind cost segregation. So if somebody did it before, cost segregation is one of those things that's nice.
Speaker 1:Even if somebody else did it, it doesn't mean you can't do it, especially if the tax year is still active. Even if somebody else did it, it doesn't mean you can't do it, especially if the tax year is still active. And so we've done a couple of those and in one case we found another 32% for a pretty high basis just by going and redoing it, and in this case we didn't charge a fee because we obviously want to get the business to the client. But whenever you find more money when somebody was already happy, I think that's the best outcome you can look for. In that case, it was a multifamily property that somebody had and it was just a matter of oh yeah, you didn't classify these in the right spot. You used this wrong case law here to justify this asset and, yeah, it was great to see.
Speaker 4:Always love to save money and give it back to our investors, which is nice, and so what question have I not asked you that? You know, our audience absolutely must know.
Speaker 1:Sure, the one thing that I would really want to throw in there I mentioned it just slightly at the beginning so cost segregation is I think we've hit on pretty well, but the energy efficiency market, specifically for developers. I think this is one of those areas which there's been some activity in, but it's gotten way less. And the reality is the Inflation Reduction Act did a disservice to the energy efficiency play that was available to builders and developers. Something that was intended to incentivize green building and green development and to generate more housing has actually kind of crushed them a little bit, and I do think parts of that's going to be changing, but the parts that are still available. So you have a 179B and 45L. 45l is something that's a per door energy credit which potentially could impact some of your investors, but until the law changes any multifamily, it's not going to be worth the cost to do it unless you pay prevailing wages and apprenticeships, everybody involved in the development of the project, and I just don't think anybody's doing that. So I would put that one to the side for now and say let's see if prevailing wages goes away. 179d, though 179D is interesting because in both cases Inflation Reduction Act took a benefit and they multiplied it times 300% and said, hey, we made the benefit so much better, aren't we great? The only problem is it'd be like sitting in a group of a bunch of people who are five feet tall and say I will give you $20 million so you can dunk a basketball. Okay, I'm going to get a hundred million. They still couldn't dunk the basketball For 45L. That's what happened For 179D. It also happened a little bit, but for 179D they gave people an out and so anybody listening who has built any type of facility and they began construction before 2023 and the property went into service into 2023 and beyond. The benefit went from a dollar and change to $5.60 a square foot and you are exempted from having to pay prevailing wages if you started construction before 2023.
Speaker 1:There's a lot of people sitting on this massive, massive deduction. They can take right now that are exempt from prevailing wages but don't even realize it. Take right now that are exempt from prevailing wages but don't even realize it. And what 179D is? It is an energy efficiency tax deduction that requires certain standards are met for LED lighting, for walls, insulation and also HVAC unit. The way you go about getting this deduction is within the law. You have to use a third party, so it cannot be an entity tied to your business. You also have to have somebody who is a professional engineer licensed in the state where the property is located. So if you own three properties in three states, you better find somebody with a lot of certifications. I can tell you we have 48 of them, so there's only three that we could support you on right now. But you also have to get energy modeling done. That energy modeling has to be validated by that individual and also they have to walk the facility to validate the modeling and sign off on it as a professional engineer and that gets you the deduction. It's interesting that taxes have been so tied into green and to labor but as a result I've had to hire somebody who's an energy star expert who kind of became a tax expert in the process. So that's the big piece and I would encourage anybody in your podcast who wants to explore that, especially if you fit in that exemption that can be tacked on to a cost segregation and both 17090 and cost segregation, even if you bought a property in the past and you haven't capitalized on it yet.
Speaker 1:Both of these things do not require to amend a return. They have what's called catch-up depreciation. There's a form that can be filled out. We actually filled it out for your CPA, I think, to support 11,000 CPAs you could imagine we get a lot of pushback saying can you fill out some of these forms for us? It's not too late. And that was one of the pieces I would say to your other question, john, was when it might not make sense. If you owned a property for 25 years, you probably mostly depreciated the assets for those times. But if you're, still, say, within like a seven, eight, nine, maybe even 10-year window, depending on what you paid for it there, could still be a lot to go get and you don't have to move powder and earth to get it.
Speaker 4:Oh, fascinating information, chris. I wanted you on the show because I had no idea myself. I'm not a tax expert, but meeting you and having you speak at the conference really opened my eyes and I'm always looking for individuals like yourself that can come onto the show and educate our owners, our investors, families that own buildings, multifamily, whatever it may be. But thank you so much and once again, tell us about your company. How do they get a hold of you? What's your website address so that they can get a hold of you? For 17090, or cost segregation studies or a combination of the both.
Speaker 1:Sure, so we're Cost Segregation Authority. Cost Segregation Authority my East Texas makes me say it all as one word Cost Segregation Authority. We're based in Utah, so just around the Lehigh area of about 80 folks. Again, this is all we do. Cost Segregation Authority is the website costsegregationauthoritycom, just to get access. There is a contact us form on there. But also I'll say my email really quick as well. You can email me directly and I'll get you to the right person Cstreet S-T-R-E-I-T. At costsegauthoritycom.
Speaker 4:Cool. Thank you so much. Appreciate it and this information is very valuable and I appreciate your time today, Chris.
Speaker 1:Awesome, really appreciate you, john. Thank you for the time. Thank you for having me on.
