How Cost Segregation Can Help You Save on Taxes as a Passive Investor

Successful investors are always looking for ways to lower their tax liability.  One of the most impactful ways to reduce taxable income is by owning rental properties directly or by investing passively in real estate syndications.  If you go the passive route, in most cases the sponsor will utilize a cost segregation study to maximize and accelerate depreciation.  This offers the investor a unique tool to consider in their tax planning strategy.  In this post, I will discuss how cost segregation works and how it can affect your personal finances.

Commercial buildings qualify for straight-line depreciation over a 39-year timeline, while residential real estate depreciates over 27.5 years.  By using cost segregation, operators are able to accelerate, or pull forward, future deductions over a much shorter time period.  Cost segregation aims to divide up the entire property into sub-components and then reclassify those components as real property, personal property, or land improvements. This breaks the individual components of the property down to their respective, estimated serviceable life, which may be 5, 7, 15, or 27.5/39 years.  A roof, for example, will typically last for 30 years or so, while carpet may only be in service for 5-7 years before it needs to be replaced.

Furthermore, the Tax Cuts and Jobs Act of 2017 allows for properties placed into service between 2018 and 2022 to qualify for 100% bonus depreciation on 5-, 7- and 15-year replacement items, at which point it will be phased out through 2026.  This allows for potentially large depreciation write-offs in the tax year that the property was placed into service (purchased)!  In the case of direct real estate investments, this could be a tactic used to free-up cash flow for improvements to the property.  For the passive investor, it produces an outsized paper loss that can be used to offset distributions and any other qualifying investment gains made in the tax year.  If you offset your passive gains with the paper losses generated from the depreciation and still have some left over, they will carry forward to the subsequent years until they are completely used.

So what does this mean for you as the passive investor? The impact is best illustrated in a stripped-down example.  Let’s look at a commercial property with a cost basis of $20 million.  Let’s say the land is worth $1 million, which is not depreciable.  Using straight line depreciation, the syndicator would be able to deduct $487,179 ($19 million/39 years) off the net operating income that the property earned.  This deduction will get passed through to the individual, passive investor, who owns a 0.5% stake in this deal.  For the purposes of the investor’s tax return, the investment in this property results in an allowable deduction of $2,436 (0.5% of $487,179).

Now let’s look at how a cost segregation study would impact this same scenario.  Using this tool, the study will reclassify things like appliances, carpet, window treatments, etc. into 5 year items.  Other items would fall into categories of 15 years, like sidewalks, parking lot, exterior signage, etc.  The remaining building structure would remain at 39 years.  Let’s say the cost seg study reveals that 21% of the $19 million can be classified as 5- or 15-year items and 100% of those items can be written-off in year-one through bonus depreciation.  

The depreciation write-off expense for the property increased to $3,862,559 in year one!  The passive investor who has a 0.5% stake in the asset now has a pass-through paper loss of $19,313, which is eight times more than the straight-line depreciation deduction of $2,436.  If that limited partner has a combined federal/state tax rate of 35%, that would result in $6,759 going back into the investor’s pocket.

I would be remiss to not mention that these dollars “saved” are not a gift from the IRS.  The taxes are deferred until the asset is sold, at which point depreciation is “recaptured.”  There is no free lunch!  The time value of money proves that a dollar today is better than a dollar tomorrow, however.  This concept draws parallels to how a 401K or IRA maximizes growth by deferring taxes on capital gains until money is withdrawn.  Accelerating depreciation puts more money in your pocket on the front-end, allowing you as the investor more capital for other investments to earn additional returns.  When your capital is returned to you by the syndicator at the time of sale, there will potentially be a large tax liability due April 15th.  A simple way to continue this tax deferral is to roll your proceeds from the original investment into another syndication that plans to use cost segregation as part of their business plan.  Most do, but be sure to ask during your due diligence.  If they do, the new cost segregation study will help offset the depreciation recapture from the original investment.  Rinse and repeat. 

 Cost segregation studies and bonus depreciation can have a massive effect on the amount of taxes you pay.  Even if you are not expecting a tax year with significant passive gains, the benefits of cost segregation studies can be immense in the right circumstances because passive losses carry forward indefinitely.  Many investors aren’t aware that cost segregation is not limited to just commercial buildings.  You can use cost segregation on a portfolio of single-family homes as well.  Whatever your situation is, don’t let the tail wag the dog when it comes to considering investments.  Tax planning is important, but it has to be a good deal that fits your risk tolerance above all else.  However, if you do have gains to offset, consider passive syndications as a route to shelter tax liability, especially now, with the new administration taking office at the time of this writing.  These super-charged tax advantages may not be here for long! 

 

Paul Shannon is a full-time active real estate investor, as well as a limited partner in a number of syndications.  Prior to leaving the corporate world, Paul worked for a medical device company, selling capital equipment to surgeons in the operating room.  After completing a few rehabs employing the “BRRRR method”, he saw scalability and more control over how he spent his time, and left to pursue real estate in 2019.  Since then, Paul has completed over a dozen rehabs on both single-family and multifamily properties.  He currently owns over 50 units in Indianapolis and Evansville, IN and is a limited partner in larger apartments and industrial properties across the US. You can connect with him at www.redhawkinvesting.com

Nothing on this website should be considered financial advice. Investing involves risks which you assume. It is your duty to do your own due diligence. Read all documents and agreements before signing or investing in anything. It is your duty to consult with your own legal, financial and tax advisors regarding any investment.

Chris Franckhauser

Vice President of Strategy & Growth, Advisory Partner

Chris Franckhauser, Vice President of Strategy & Growth, Advisory Partner for Left Field Investors, has been involved in real estate since 2008. He started with one single-family fix and flip, and he was hooked. He then scaled, completing five more over a brief period. While he enjoyed the journey and the financial tailwinds that came with each completed project, being an active investor with a W2 at the time, became too much to manage with a young and growing family. Seeing this was not easily scalable or sustainable long term, he searched for alternative ideas on where to invest. He explored other passive income streams but kept coming back to his two passions; real estate and time with his family. He discovered syndications after reconnecting with a former colleague and LFI Founder. He joined Left Field Investors in 2023 and has quickly immersed himself into the community and as a key member of our team.  

Chris earned a B.S. from The Ohio State University. After years in healthcare technology and medical devices, from startups to Fortune 15 companies, Chris shifted his efforts to consulting and owning a small apparel business when he is not working with LFI (Left Field Investors) or on his personal passive investments. A few years ago, Chris and his family left the cold life in Ohio for lake life in the Carolinas. Chris lives in Tega Cay, South Carolina with his wife and two kids. In his free time, he enjoys exploring all the things the Carolinas offer, from the beaches to the mountains and everywhere in between, volunteering at the school, coaching his kids’ sports teams and cheering on the Buckeyes from afar.  

Chris knows investing is a team sport. Being a strategic thinker and analytical by nature, the ability to collaborate with like-minded individuals in the Left Field Community and other communities is invaluable.  

Jim Pfeifer

President, Chief Executive Officer, Founder

Jim Pfeifer is one of the founders of Left Field Investors and the host of the Passive Investing from Left Field podcast. Left Field Investors is a group dedicated to educating and assisting like-minded investors negotiate the nuances of the passive investing landscape and world of syndications. Jim is a former financial advisor who became frustrated with the one-path-fits-all approach of the standard financial services industry. Jim now concentrates on investing in real assets that produce cash flow and is committed to sharing his knowledge with others who are interested in learning a different way to grow wealth.

Jim not only advises and helps people get started in passive real estate syndications, he also invests alongside them in small groups to allow for diversification among multiple investments and syndication sponsors. Jim believes the most important factor in a successful syndication is finding a sponsor that he knows, likes and trusts.

He has invested in over 100 passive syndications including apartments, mobile homes, self-storage, private lending and notes, ATM’s, commercial and industrial triple net leases, assisted living facilities and international coffee farms and cacao producers. Jim is constantly looking for new investment ideas that match his philosophy of real assets producing cash flow as well as looking for new sponsors with whom he can build quality, long-term relationships. Jim earned a degree in Finance & Marketing from the University of Oregon and a Master’s in Business Education from The Ohio State University. He has worked as a reinsurance underwriter, high school finance teacher, financial advisor and now works exclusively as a full-time passive investor. Jim lives in Dublin, Ohio with his wife, three kids and two dogs. In his free time, he loves to ski, play Ultimate frisbee and cheer on the Buckeyes.

Jim earned a degree in Finance & Marketing from the University of Oregon and a Master’s in Business Education from The Ohio State University. He has worked as a reinsurance underwriter, high school finance teacher, financial advisor and now works exclusively as a full-time passive investor. Jim lives in Dublin, Ohio with his wife, three kids and two dogs. In his free time, he loves to ski, play Ultimate frisbee and cheer on the Buckeyes.

Chad Ackerman

Chief Operating Officer, Founder

Chad is the Founder & Chief Operating Officer of Left Field Investors and the host of the LFI Spotlight podcast. Chad was in banking most of his career with a focus on data analytics, but in March of 2023 he left his W2 to become LFI’s second full time employee.

Chad always had a passion for real estate, so his analytics skills translated well into the deal analyzer side of the business. Through his training, education and networking Chad was able to align his passive investing to compliment his involvement with LFI while allowing him to grow his wealth and take steps towards financial freedom. He has appreciated the help he’s received from others along his journey which is why he is excited to host the LFI Spotlight podcast and share the experience of other investors and industry experts to assist those that are looking for education for their own journey.

Chad has a Bachelor’s Degree in Business with a Minor in Real Estate from the University of Cincinnati. He is working to educate his two teenagers in the passive investing world. In his spare time he likes to golf, kayak, and check out the local brewery scene.

Ryan Steig

Chief Financial Officer, Founder

Ryan Stieg started down the path of passive investing like many of us did, after he picked up a little purple book called Rich Dad, Poor Dad. The problem was that he did that in college and didn’t take action to start investing passively until many years later when that itch to invest passively crept back up.

Ryan became an accidental landlord after moving from Phoenix back to Montana in 2007, a rental he kept until 2016 when he started investing more intentionally. Since 2016, Ryan has focused (or should we say lack thereof) on all different kinds of investing, always returning to real estate and business as his mainstay. Ryan has a small portfolio of one-to-three-unit rentals across four different markets in the US. He has also invested in over fifty real estate syndication investments individually or with an investment group or tribe. Working to diversify in multiple asset classes, Ryan invests in multi-family, note funds, NNN industrial, retail, office, self-storage, online businesses, start-ups, and several other asset classes that further cement his self-diagnosis of “shiny object syndrome”.

However, with all of those reaches over the years, Ryan still believes in the long-term success and tenets of passive, cash-flow-focused investing with proven syndicators and shared knowledge in investing.

When he’s not working with LFI or on his personal passive investments, he recently opened a new Club Pilates franchise studio after an insurance career. Outside of that, he can be found with his wife watching whatever sport one of their two boys is involved in during that particular season.

Steve Suh

Chief Content Officer, Founder

Steve Suh, one of the founders of Left Field Investors and its Chief Content Officer, has been involved with real estate and alternative assets since 2005. Like many, he saw his net worth plummet during the two major stock market crashes in the early 2000s. Since then, he vowed to find other ways to invest his money. Reading Rich Dad, Poor Dad gave Steve the impetus to learn about real estate investing. He first became a landlord after purchasing his office condo. He then invested passively as a limited partner in oil and gas drilling syndications but quickly learned the importance of scrutinizing sponsors when he stopped getting returns after only a few months. Steve came back to real estate by buying a few small residential rentals. Seeing that this was not easily scalable, he searched for alternative ideas. After listening to hundreds of podcasts and attending numerous real estate investing meetings, he determined that passively investing in real estate syndications was the best avenue to get great, risk-adjusted returns. He has invested in dozens of syndications involving apartment buildings, self-storage facilities, resort properties, ATMs, Bitcoin mining funds, car washes, a coffee farm, and even a Broadway show.

When Steve is not vetting commercial real estate syndications in the evenings, he is stomping out eye diseases and improving vision during the day as an ophthalmologist. He enjoys playing in his tennis and pickleball leagues and rooting for his Buckeyes and Steelers football teams. In the past several years, he took up running and has completed three full marathons, including the New York City Marathon. He is always on a quest to find great pizza, BBQ brisket, and bourbon. He enjoys traveling with his wife and their three adult kids. They usually go on a medical mission trip once a year to southern Mexico to provide eye surgeries and glasses to the residents. Steve has enjoyed being a part of Left Field Investors to help others learn about the merits of passive, real asset investments.

Sean Donnelly

Chief Culture Officer, Founder

Sean holds a W2 job in the finance sector and began his real estate investing journey shortly after earning his MBA. Unfortunately, it could not have begun at a worse time … anyone remember 2007 … but even the recession provided worthy lessons. Sean stayed in the game continuing to find his place, progressing from flipping to owning single and multi-family rentals to now funding opportunities through syndications. While Sean is still heavily invested in the equities market and holds a small portfolio of rentals, he strongly believes passive investing is the best way to offset the cyclical nature of traditional investment vehicles as well as avoid the headaches of direct property ownership. Through consistent cash flow, long term yield and available tax benefits, the diversification offered with passive investing brings a welcomed balance to an otherwise turbulent investing scheme. What Sean likes most about the syndication space is that the investment opportunities are not “one size fits all” and the community of investors genuinely want to help.

He earned a B.S. in Finance from Iowa State University in 1995 and a MBA from Otterbein University in 2007. Sean has lived in eight states but has called Ohio home for the last 20+.  When not attending his children’s various school/sporting events, Sean can be found running, golfing, shooting or fly-fishing.

Patrick Wills

Chief Information Officer, Advisory Partner

An active real estate investor since 2017, Patrick Wills’ investing journey began like many others – after reading the “purple book” by Robert Kiyosaki. Patrick started with single family rentals, and while they performed well, he quickly realized their inability to scale efficiently while remaining passive. He discovered syndications via podcasts and local meetups and never looked back. He joined Left Field Investors in 2022 as a member and has quickly become an integral part of the team as Vice President of Technology.

An I.T. Systems Engineer by trade, he experienced the limitations of traditional Wall Street investing firsthand in his career and knew there had to be a better way to truly have financial freedom.

Unfortunately, that better way is inaccessible to those who need it most. His mission is to make alternative investments accessible to everyone who seeks to take control of their financial future and to pursue their passions in life.

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