TGCI 45 – Cost Segregation Study. Magic Words That Make REI So Attractive
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In today’s show, Pancham interviews cost segregation expert, Chris Wetherall.
Cost segregation can help you save your tax-dollars thus making real estate investing an incredibly lucrative proposition. There are many nuances to this accounting practice that need to be thoroughly understood so that you do not get into trouble with the IRS.
How can you do an accurate cost segregation so that none of your deductions are disallowed? How fast can you depreciate a property? Is it possible for you to claim deductions that your CPA missed out in previous years? How do bonuses help you save your tax dollars?
For all this and much more, do not miss this special show where Chris shares some extremely nuanced information.
- 01:00 – What makes real estate an IDEAL investment?
- 02:02 – Pancham welcomes Chris to the show and shares his background information
- 03:13 – How did Chris learn the ropes of real estate and cost segregation?
- 06:50 – How fast can you depreciate a property? Chris explains the three-time scales, and reveals which properties fall under each one
- 09:44 – How your end use determines your deductions and tax savings
- 10:58 – Why is IRS giving real estate owners the option to use cost segregation to save their tax dollars?
- 12:08 – Do the various incentives make real estate the best possible investment?
- 13:40 – Real Estate – the backbone of the economy
- 17:11 – Why meticulous documentation is critical for a proper cost segregation
- 18:12 – Benefits of a fully engineered and fully accounted cost segregation study
- 21:06 – When is the right time to contact Chris and commission a cost commission study?
- 22:17 – Considering the deduction and tax savings, is it more beneficial to develop a barren piece of land?
- 28:47 – How can bonuses help you save your tax dollars?
- 30:15 – Can you use deductions that your CPA missed in previous accounting years? Is it possible to get refund checks?
- 33:05 – If you are installing a new roof, what is the amount of yearly deduction that you can claim? What is the amount of tax that you can save every year?
- 40:13 – Is the depreciation schedule reset every time the title changes hands?
- 47:02 – Is it costly to maintain documentation to a keep a track of your accounts?
- 48:37 – Have you diversified your investments and allocated an adequate percentage to real estate?
- 51:32 – Taking the Leap Round
- 51:32 – When was the first time Chris invested outside the Wall Street?
- 53:58 – What fears did Chris have to overcome when he first invested outside the Wall Street?
- 54:55 – Can you share one investment that did not go as expected?
- 56:55 – What is one piece of advice you would give to someone who is investing in the Main Street?
- 59:08 – Chris shares his contact information
3 Key Points:
- How fast can you depreciate a property?
- How can cost segregation help you save your tax dollars
- Can you claim refunds for deductions that you missed out in previous accounting years?
Get in Touch:
Welcome to the Gold Collar Investor podcast with your host Pancham Gupta. This podcast is dedicated to helping the high paid professionals to break out of the wall street investments and create multiple income streams.
Pancham: Here’s your host Pancham Gupta.
Hi, this is Russell gray co host of The Real Estate guys radio show and you are listening to the gold collar investor podcast.
Pancham: Welcome to the gold collar investor podcast. If this is your first time listening, then thanks for coming. I appreciate that you are spending time on your education. Now let’s get into the show. Whenever I am discussing investing in real estate with my friends or investors, I always get a question on how real estate is a good asset class and what are the benefits to be able to explain this easily I tell them that it is an ideal investment. I DL all stand for something. I stands for income. D stands for depreciation. E stands for equity is stands for appreciation and L stands for leverage. I cover this in detail with an example in my episode number 13. You can listen to it by going to thegoldcollarinvestor.com/show13. Really it is literally an ideal investment. Today we will focus on the deep part of it. That is depreciation. What makes real estate investing very powerful is the ability to harvest paper losses. We are depreciation on top of depreciation there is something called bonus depreciation that you can get if you were to do a cost segregation study. Today my guest Chris Weatherall is going to talk about just that. I have I’ve worked with Chris in the past, and he has done a few of these studies for our projects. And he is very knowledgeable when it comes to the study. And we get into the weeds a little bit in the shows, so bear with us on this one and listen till the end. I’m sure if you’re thinking about doing a cost segregation study, it will help you understand how this is useful. Chris, welcome to the show.
Chris: Yes. Thank you so much for having me on. And thank you for your time today.
Pancham: I you ready to fire up my listeners out of Wall Street investments?
Chris: Well, I’m ready to provide them with a very substantial and solid alternative choice maybe to be combined with their Wall Street investments or to adjunct or support some of their investment objectives. I don’t think they’re going to fly out of the wall street and probably they shouldn’t but there are some other avenues that I think will serve them very well. Great.
Pancham: Great. So before we get started, can you tell us about your brief background? Like what’s your experience in terms of real estate?
Chris: When I was in college, maybe 17 years old, I started my first company. And basically it was repairing broken windows and door locks and leaky faucets and toilets for slum Lords in the Boston area, and learned a lot about the prism stage without actually investing in it watching what other people did. And that was mostly apartments multifamily, and a few small retail things. And so I ran around like a fly on the wall, doing all these things and watching the goings on of it. But for most of my career, I’ve been involved in engineering studies on buildings and for various purposes. So that’s really my entire 50 years in the field. Going out and inspecting buildings and designing and relative to construction. And so we do invest in, in properties ourselves. But what I do now is do these studies that end up generating a very large additional cash flow for the owner of the building without them doing basically anything, the money is there. But to get at it, they need a third-party engineering verification. And that’s what I am is I’m an independent, third-party verification, I don’t sell real estate, I’m not paid by anybody other than the owner of the building as an independent representative for them.
Pancham: Got it. And going into your experience, which is, you know, doing these studies on existing buildings. Let’s talk about the cost segregation study. You want to explain like what what is a cost segregation study, and also what is the history behind it and why it made it into tax code.
Chris: Well, I actually started doing These studies I really had no idea what I was doing. But my my large clients, which were General Electric, Westinghouse, Schlumberger, DOL, International Paper champion paper companies like that. I was doing industrial, military nuclear services work. And they would ask me about certain things are, I’d be climbing up on a 300-foot stack. And they would say, Well, Chris, while you’re up there, get some samples of the mortar and take some pictures, and I was Mr. Friendly, I would do whatever, because I wanted to help them and be in a good relationship with them. And so they ended up asking me to go in and look at things and count things and write up little reports. And this was with film cameras back in the 80s. I had no idea what I was doing. And then one day after, maybe I got three of these different requests. In the course of a year I got suspicious about why I was being asked to take these reports up to the accounting department because usually I went to the head of maintenance or the chief engineer’s office or something like that. As like, why am I Going to the accounting office. Why did they want to know about this stuff, and I got a person in the head of accounting that I knew. And I asked him and he explained to me the tax code, it changed. And at the time, it was called component unit depreciation. And I asked him, Well, what did this mean to him in terms of money, and I kept a straight face as I possibly could. But you know, what I had done, which took me maybe a couple of hours was worth a quarter of a million dollars to them. So right then the light bulb went on. And I was actually doing these studies for free for four years, in order to get the regular industrial services work that I was after. So those companies taught me how to do this. And then in the late 90s, there was other changes in the tax laws, which turned into what’s called cost segregation. So what happens is a building, there’s three scales of time in which a building a property can be depreciated. One is 10 years that’s agricultural greenhouses. chicken houses barns, so we don’t care about that they get advanced accelerated depreciation. In other words, they get their money back quick, because farming is risky. And then there’s 27.5 years, which is apartments multifamily. And that’s all that is. And then there’s 39 years which is basically everything else hotels, shopping centers, dental offices, golf courses, marinas, everything. And there’s a lot of little sub things to this. It’s the tax code, and it’s complex, but that’s what I do for a living. So that’s not to be concerned. So what I’m going to do is take what would happen in a perfect world anyway in 39 or 27.5 years, and I’m going to compress a whole bunch of that to happen within the first 15, seven or five years. Okay, so those are the three buckets that I can bring the deductions into. And so, fundamentally, what you’re looking at here is an acceleration in time, which is translating directly into one reduction in risk. So does that make sense so far? Yeah, it makes sense.
Pancham: Going back to your initial experience, and you were literally doing this for free for these companies. My question is like, was it like 1987 or 1986? tax code change? It’s brought this into the IRS code, or was it even before that?
Chris: Well, it was in the 80s. Before that, there, everything was straight line, you would just buy something for $100. And then you would depreciate it over 39 years, or whatever the depreciation time scale was at the time I don’t not really familiar with straight line depreciation back in those days, because I wasn’t exposed to it until my customers were very sophisticated, had their own internal legal and accounting departments. They got right on this and then I was just the guy that would go out there and take the pictures because I was there anyway and I was you know, had my steel toed shoes and My hardhat my safety gear, and I could just go out any place in the plant and get what they want it. Right? So that was really there wasn’t anybody doing this and they don’t really have anybody on staff that could do it. So I just kind of accidentally fell into that position and especially I was, you know, freight so high.
Pancham: So fast forwarding it to now like so you. In other words, what you’re saying is that the straight line depreciation for residential buildings is done over 27 and a half years, what you are doing is you are taking all the components that the building is made of, and you divide them into three separate categories 15 years, five years and 10 years, is that right?
Chris: Well, there’s a seven year, Pancham but there’s almost nothing in seven year okay, in a family that would be more for industrial. So as a practical matter, there might be a tiny bit in seven year but you’re really looking at 15 year which would be Something like the asphalt in the parking lot could go from 27.5 to 50. And then something like a duplex receptacle in the wall. That might be a 27.5-year item. But if it has a toaster plugged into it or floor lamp anything, then it’s in service. And that would be a five-year item. So it’s not only the thing, but it’s the use of it that matters. So this is a little bit more complex than what you would assume. And if every duplex receptacle in the room was had something in it, no, I couldn’t take every receptacle, I would still under the code have to leave one or more depending on the square foot of the room. So I don’t want to get down in the weeds here. But I just want to let you know this isn’t as simple as just going walk in the room and counting stuff. You have to know what you’re doing.
Pancham: Right. So like I want to circle back a little bit like why is IRS giving this incentive? Why is this in the tax code and for real estate owners?
Chris: Okay, So let me go wax philosophical here and go into the macro economics of this. Okay. 70% of the US economy revolves around real estate. Real estate is a sitting duck. It is there, you cannot pick it up and move it. And when people are living in a home living in an apartment running a store, there’s lower crime, there’s higher rates of education, there’s more employment, the economy is cooking. So what the IRS did is they looked at this in terms of being able to stimulate the economy, create jobs, and having a good conduit for the flow of money. So focusing on real estate, is what the government is doing. They want money to go towards real estate now, want to make a really, really, really big point here. And I’m going to state this in a way that I bet nobody has ever heard real estate talked about this way. So absorb what I’m saying, Don’t jump at it and don’t say, Oh, that’s wrong or start picking it apart. Just hear it. Real estate is a specific type of capital asset, where if you put your money into this type of capital asset, you are guaranteed by the government to get your money back. Nothing else does that. If you put your money in gold stocks, bonds, fine art, antiques, whatever, you are not guaranteed to get your money back. But if you put it in real estate, over 27.5 years or 39 years or 10 years, through depreciation and deductions, You are excused from having to pay that much tax. So that’s an incentive to have you put your money in that particular type of capital asset because it’s a big reduction in risk. So If you have a choice to put money into gold, it’s going to go up, you sell it, you pay capital gains or whatever income tax. In real estate, this doesn’t even make sense. The real estate at the same time that’s going up in value, you are allowed to depreciate it, if you landed on this planet from wherever, and you saw people doing that it would not even make sense to you. But this is so common that nobody really starts to make the distinctions between real estate and the unique aspect of this particular type of capital asset. So I would like people to believe that our stock investors are buying investors to think hard on this, that this is why the government wants money directed towards real estate because 70% of the US economy runs plus or minus around real estate. And if you put money into real estate, it’s increasing the value. It’s increasing local property taxes, local governments are not going on the dole to the federal government. There are more grilling opportunities for people to go to Home Depot and fix it up or deploy the lawn care, or the painters, the carpenters, the plumbers, the electricians, all of those people actually pay taxes. Now, my company, your company, somebody else’s company, yes, of course we pay, we write to the government a check, and we call it paying taxes. But a company doesn’t actually really pay taxes. At the end of the day, it’s a cost of doing business that’s baked into whatever product or service they’re selling. People that really pay taxes is Pancham personally and Chris, personally, where the end of the line and so is the person that cuts the lawn and the painter and the carpenter. So this is all about Velocity of Money, the Treasury wants the money to hit the ground, fast bounce and turn back and go back to the Treasury. So the more people are being employed, the fastest way to spread the money out and employ the most people without favoring any particular group is real estate. It’s the perfect conduit for the government to get the money out there to perfect. Kinda wait for the government to get the money in the hands of people that actually pay taxes and have the money bounced back, go back to the Treasury. And that Velocity of Money is what creates the economy moving faster, right? Is that too much?
Pancham: No, that’s great. This is great. Having that context is great. So you’re saying that because the Treasury or the government wants to create the velocity of money and real estate happens to be the, one of the biggest components, which helps them do that? That’s why they give these incentives in the IRS tax code for people to you know, incentivize them to buy real estate so that then they can avail these incentives.
Chris: Absolutely correct. And I can tell you that every once in a while, I’ll be in a meeting or someplace, and somebody will come up to me says, Oh, so you found a loophole and tax code. Oh, well, you know that Oh, you could get audited for it. Oh, that’s cheating. Old. I’m like No, this is actually a United States Treasury program where they want you to do this. They’re encouraging you to do this. This is not a loophole. This has been in the tax code for decades. And under our system of government, it would require both houses of Congress and the President to sign it in order to change this. This is not a like just came out yesterday, incentives for buying more energy efficient windows or something like that. No, this is totally how it works. Yeah, no, I had that too. All the time, that these are the loopholes. And why are you know, taking it like benefiting from these loopholes? These are not loopholes. These are the incentives. That’s what I tell them. Right. There’s lots of conspiracy theory and you know, what’s this and what’s that and a sign that kind of stuff is entertaining. They found a three headed cow in the farm of Browns field and, you know, the Enquirer. Whatever. But this not this. I’m a very conservative person. I’ve been doing this for over 20 years, I’ve done thousands upon thousands of studies which have 10s of millions of items within those studies. And the way that we do the study, I have never had a single item in a single study ever disallowed. It’s not because I’m good at arguing. It’s just meticulous documentation. If you follow the rules meticulously, and you document everything you’re doing, that’s what the government’s looking for. And that’s what we deliver. And I want to just go off to the side here, cost segregation studies. What is really called under tax code is modified accelerated cost recovery system. Modified accelerated cost recovery system. That’s technically what we’re talking about. Everybody calls it cost segregation. Just like if you want somebody to go down to the store to get you some, you know, tissue to blow your nose. You’re gonna say get me a box of Kleenex well That’s a Kimberly Clark brand. And there’s scar tissue. There’s, you know, all kinds of other ones, but everybody calls everything clean, to the point where Kimberly Clark actually lost their, their rights to own that as a brand. So there are actually six different types of cost segregation studies out there. And I would like the listeners to be very cognizant of what I’m saying 98% or more of all the studies that are done are not, not the type of study that I do. I specialize in only the fully engineered and fully accounted study. This is the only type of study that allows you to retire assets taken out of service and recover the unused tax deducted life of those assets. So when I was doing this, there was almost nobody else. This was just big companies. And then after 911, the government decided to look at ways to stimulate the economy. And so they created a bonus of 50% bonus, that’s Really, when the cost segregation business started to be a big business, and lots and lots of people are out Hawking this or selling it, they don’t even do the study. They’re just out selling it, I actually go in and do the field work. And I’m not the only one in our organization that does it. And I’m not certainly the only person is there’s a lot of people involved in putting the study together, not just me. I’m one component of it. But I used to do what were basically I was the only one doing the whole thing. And then the accounting department at the big company would handle the rest of it. So just when you’re purchasing a study, you really want to know what you’re buying. And the price up front is not what counts, it’s very easy to charge a cheap price. Because all certification study is 90 something percent labor, it’s easy to charge less you just cut back on the labor. But by cutting back on the labor, you significantly reduce the benefits. So everybody’s price price, price price. That’s not the way to look at a study you want to look at results. You want to look at how solid and how defended those results are, that’s really the point is to get some education about what you’re buying for study. That’s what’s really important is the net results of it.
Pancham: Now, right now, that’s absolutely true. And we have done business in the past. And I can truly attest to that, that the studies that you have done have come out great. And you can always refer it back to the spreadsheets that we have provided. Like I want to kind of go back from a point of a person who has actually never got a study gun. And you know, you mentioned few things like you have been retiring the components of the building and use them. So let’s take an example and walk through this cost segregation study. How would that help for from a point of view of a person who has never done a study and they let’s say own million-dollar building, and how would this help them? Can you like break that down, you can use whatever example you want, like how this will help and how you can retire things?
Chris: Well, first of all, I would like to state that people often ask, Well, when should I get the study done or when should I call you are all right? First of all, follow me when it’s a twinkle in your eye. Call me before you buy it, call me before you design it. I actually have an AIA approved course for architects called tax favorable by design, you can design a building in the beginning that has tax favorable aspects to it. And I don’t tell the architect or the builder or the client what to do, but they just don’t know that there’s a difference between a rug and luxury vinyl tile, luxury vinyl plank, linoleum with glue it down with there’s all these things lights in the ceiling, wall sconces, all these things have a different aspect to them, as far as the deductibility and how fast you can get your money back. So if there’s any way that I can get up on the front end of before you buy The building, let’s take a look at what’s going to look like once you do buy it. And then let’s look at structuring the purchase. Another really, really, really big point. What are you paying for the land? So in the beginning, I really want to talk to people and have a good discussion about what are you paying for the land, I cannot tell people what to do. I’m not giving tax advice or legal advice. Nothing that I’m saying here is tax advice or legal advice. This is just an explanation of what is you have a legal right to do under US tax law, and you should talk with your CPA, your tax attorney, other people about this. But if you’re looking at the purchase, everybody will default to Oh, well, the property is valued by the city, the town, the county, and this is the building and this is the land. Oh, you can’t argue with the government. Well, I’m not arguing with the government, you aren’t either. The government’s purpose for valuing the land and the building of whatever it is, is fairness and equity and taxation amongst all the property owners within that jurisdiction. So their valuation is really to spread the load over a lot of people. And that’s fine. We’re not challenging that. But when you own the piece of dirt that you’re building sitting on, what is it worth to you? Is the only purpose of that dirt to keep the building from falling through China? Or, you know, is there a double lot you could build and you could put storage building facilities on there, you could add on another apartment building, the land may be worth more than the government says it is. I’m not saying that. I’m just saying let’s take a fresh look at what is this land worth to you whether easements right away is cross connection driveways, what’s going on with this? How close is the building to the property lines, the building burned down? Would you actually be able to build that building again, or with current codes forbids you from doing that? Because of the setbacks. There’s a lot of things that I can help people with to have their own thoughts about developing what is This land worth to them and then buying that land for the specific price. Not you know, $1 that’s stupid, and you can’t do that. But you do something that is justifiable, that makes sense to you economically as the owner of that land using it for the purposes that you’re going to use it for.
Pancham: The idea behind that is that because land is not depreciable so the you want to get the value of the land as part of your cost segregation study so that you can take the purchase price and the does the value of the land and then do your calculations based off that number. Is that right?
Chris: You said it extremely well and much simpler than me. I mean, if you asked me what time it is, I’ll start explaining how the watch works. That’s just it’s very good for certain, but not necessarily for a radio interview. But anyway, that’s well put, and you might as well dig a hole and put the money in in the hole and bury it because you’re never going to see that money again. It’s not gonna gain in value, not depreciable. It’s just zero, whatever money’s in the land, but like I said, it can’t be something stupid. It has to be something that’s reasonable and justifiable. It might be more than what the government says it might be less, but everybody is so totally locked into it. And then they buy this building land and buildings lump sum. Now you’re leaving it open for discussion and argument later. That’s what I would like to help avoid. And then I get all kinds of ridiculous pushback. Oh, you can’t divide up the land and the building. Oh, you can’t do that. Well, what do you call a ground lease, ground leases, you know, dividing up the land and the building. So there’s good strategic ways of setting this up right from the beginning, before you even go to closing. And then after closing, what we’re going to do is we’re going to look at what kind of improvements you’re going to make. How are you spreading these improvements out? If it’s a multi-family, maybe every time the apartment turns over, you’re going to remodel that apartment? Maybe you’re just going to get everybody out of the building, have the building be vacant for four months, and you’re going to remodel everything. There’s different ways that you could go about doing that. And we can discuss it, we can discuss and see what I can provide you with a more granular view of what’s going on.
Chris: So you can make a better decision, it’s going to be your decision, right?
Pancham: So, let’s say, you know, I want to go back to an example so that it’s easy for someone who has never done a cost segregation study to see how things will pan out. So let’s say the building is worth 1 million and the land is 250. So the person bought the entire building and plus the land together for 1.25 million. Right? So now you come in and let’s say the person is not planning on making a lot of improvements is going to hold it like how would you go about the cost segregation study, and then what would be the outcome of it and how much a person can expect to depreciate the very first year based on…
Chris: Well, that’s a question which I do not have a good answer for, because it’s really going to depend on so much of what is there in the building. But what we’re going to do is we’re going to do at no cost and initial analysis and a detailed calculation on what is available. So on a case by case basis, and I appreciate what you’re asking me, everybody, how much is going to cost? How much is going to cost? What am I going to get out of it? I just don’t work. That way. You can find plenty of people out there that will quote, you know, quote, years per square foot or here’s what we’re going to do. I am absolutely depth on creating unfulfilled expectations. I want to know what exactly I can deliver for a client before I engage in doing anything. So I’m fine with spending an hour to three hours analyzing it, looking at it doing the math is nothing, they’re fine. We made a good effort to check it out. There’s something there presented to the client. They don’t Want to do anything fine. It’s their money, do what they want. But I don’t present anything to anybody that isn’t really substantial results. And that’s all going to be calculated based on a decent estimate of their ordinary income rate. You know, what is the situation. So, if they don’t plan on remodeling it, they’re just buying it as if it’s a Class C, or maybe Class B apartments, they’re still going to get a really high percentage of that total amount of assets that are in the building in year one right now, because there’s 100% bonus on what we do. And I want to digress a little bit explain the government’s version of bonus. So you know, the toothpaste company Oh, 20% more toothpaste for the same price or 20%? Two, three, or, you know, everybody’s got a way of spinning what a bonus is, well, the government’s version of a bonus in terms of cost segregation is once I’ve got Have from the 27.5 or 39, year down to the 15, seven or five. And anything that ends up in the 15 seven or five bucket will then be further accelerated into the year one bucket. That’s what 100% bonus is. In other words, 100% of everything that can be shortened in time will be further shortened in time to year one. Now, I’ve also had a CPA that I know quite well, she’s super bright, and I did a dentist client of hers and she’s like panicking. Oh my god $600,000 in deductions who sent us into the IRS would be audited for sure this is this is horrible. And I’m like, No, no, wait a minute. Just because you got all those deductions doesn’t mean you have to use them. So there’s a lot of granular aspects to this, but Depending on the client circumstances between the CPA and the client, they decide how they want to meter out these deductions. But if you go with the regular non cost segregation way of depreciating property, if you don’t take deductions, you’re actually penalized. You actually lose them forever if you don’t take them. Also, there’s another aspect to this, if someone has just talked about somebody buying a building, if somebody has owned the building for even 10 years, I can literally go back 10 years and sweep through the last 10 years and bring forward all the deductions that were missed. Now, once again, that’s not nice way of saying it. It sounds like the CPA missed something. No, they did not miss anything. You can’t take these deductions unless you have this particular method of accounting going on. And it’s not complicated if you have cash accounting, accrual accounting, different accounting methods. This is a particular type of accounting method that’s common in, you know, that’s modified accelerated cost recovery system. That’s a specific accounting method for real estate that allows for this. So once we convert it into this accounting method, which is essentially not difficult to do, then I can comb through the last 10 years, bring forward all of these deductions, and now they’re available. And in fact, in certain cases, the CPA could go back and refile and actually get a check back and I’m doing that for a number of clients right now, with this current virus situation. hotels are shuttered, they have no money, they’re looking for cash, we’re going back and getting them the ability to get big refund checks. Alright. So a lot of aspects to this that can be extremely useful in reducing risk. That’s the point of doing this point and doing this is not so I’m going to get a big, you know, extra deduction that is so limited in its thinking. Hi, this is a method of accounting. Once you get this method of Accountancy in place, this is the granular way of managing this particular type of capital asset. Modified accelerated cost recovery system is specifically designed for real estate. And it’s the way to own real estate. Every single one of the Fortune 500 companies that owns real estate does this.
Pancham: You know, I want to go back and kind of learn a bit from you on how the mechanics of retiring a component work in real sense. So let’s say if I have a building, and the building is worth $1 million, and the land is 250, and I’m trying to replace the roof on that building, and the roofs are costing me about $50,000 to the brand new roofs or, you know, for $50,000 and let’s say I bought this building one year ago, how would this work and how will this study helped me and regarding order and buying the $50,000…
Chris: Okay, so what we’re going to be doing with this million-dollars on this building is we’re subtracting the 250 for the land, which sounds like an awful lot, I think that’s maybe kind of hype for the land, but that was something we’d look at. So 750,000 is left, we’re going to take $750,000 worth of peanut butter, and we’re going to spread it over all of these thousands of little slices of bread and crackers and cheese and whatever that are the components of the building. So if you just think about it like that, we’re going to butter every single piece of that building all the duplex receptacles every square foot of flooring, wallpaper, Chair rails, doorknobs, windows, lighting, all of this is going to get a little piece of that $750,000 a portion to it, and how that’s apportioned depends on what the thing is, and it depends On what it’s being used for. So let’s say that you’re spending $50,000 to replace the roof, that does not mean that the roof that’s being removed is worth $50,000. Because the roof that’s being removed is worth a portion of the basis, the 750,000 that you paid for the whole building. All right, so that is the current calculation where we’re going to forensically recreate a value for that roof that will stand up to audit under Treasury rules. And what this does sound more complicated than it is because nobody’s going to do that part of it other than us. But just because a 50,000 doesn’t mean you’re removing 50,000 you may be removing 35,000. So let’s take that for an example. Let’s say as it turns out, that the old roof is forensically, absolutely under Treasury rules worth 50,000. Now, if you put 35,000 if you put your $50,000 roof on top top of your existing roof, you get nothing. Because that existing roof is still affixed to the building. And even though it’s under the new roof, it doesn’t matter. It still was not removed from service according to Treasury rules. So this is often a calculation where people like oh, it’s cheaper to just cover it over. Not necessarily. It’s maybe cheaper to cover it over immediately. But I can tell you almost certainly it is not cheaper to cover it over. Because if I can recover the unused, tax seductive life that’s embedded in the roof. Now you said that was one year. So let’s say that the roof is $35,000. We’ve established a value of 35,000. So we take 35,000 and you said is 27.5 years it’s been in an apartment. It’s been in existence for a year, so you have 26.5 years remaining. So let’s take 35,000 divided By 26.5 and we get one sound one question that Why are you taking crank a 6.5? Note, you’re basically subtracting I’m sorry, I did that I did that wrong. You’re right, it’s 35,000 divided by 27.5. And that’s going to give us about 1200 and $72 1200 $73 a year in depreciation. So there’s some granular stuff to this. We’re trying to make this simple, right, so now we take all 72 and we multiply that times 26.5. And we get $33,727. So in other words, after a year, and then depreciating over more time, but the music stops because you’re replacing the roof and you have $33,727 left in depreciable life. Now if you shove a lead into the dumpster and you do not have this particular type of study in place, This money has gone forever. You never recover. This is not part of No Return basis when you sell it is gone forever. So does this mean in terms of cash? Well punch him, What is your ordinary income rate? What is your tax rate? Yeah. Okay, so 30% so we take this 33,007 27 times point three, and we get $10,118. So $10,000. So it’s actually $10,000 cash in hand, that you just shoveled into the dumpster, never to be seen again. So if you take 35,000 is the value. This is what’s actual cash that you’re throwing away at 30% ordinary income rate. I hope people are following that. Now you paid 50 to place the roof. So what is 10,000 Cash of the 50,000.
Pancham: Yeah, it’s 20%. Yeah.
Chris: Yeah. So you can see that this is a very significant percentage in reducing the cost of what you’re putting on there. And the planning of looking at, well, gee, do I want to cover it over? Or do I want to strip it off? And this will apply to everything in the building? Am I going to cover over the linoleum with a rug? Am I going to take the rug and rip it up? Am I going to remove the wallpaper? I’m going to paint over the wallpaper. What am I going to do? And when am I going to do it? So going forward? You can actually look at things like, well, gee, I bought the building five years ago. Let’s look at the carpets. Let’s look at this. We’re looking at refreshing. Oh gee, well, the carpets were depreciated over five years. Well, they’re fully depreciated. Well, that’s okay. Well, we bought the building three years ago, the carpets are depreciated over five years. Well, do we want to wait another couple of years until they’re fully depreciated or do we want to do it now and recover the money, you get a lot more granular ability to make good business decisions. That’s what this is about is perfect. finding information that you can make good business decisions about what you’re going to replace when you’re going to replace it. What are you going to replace it with? I’m going to replace the floor. One question on the roof, right?
Pancham: Like I want I’m sure some people are thinking about this as I speak. The question is that you took 27 and a half years and the divide, you took that 35,000, and you divided it by that and then you multiply that by 26.5. Because it was already one year into service. The question is, that is the tax life of it right? The roof might be very, very old already. That doesn’t really mean the roof is one year old and we are replacing a one year old roof. That just means that the roof might be 25 years old roof. But the tax life is 27 and a half, which started when we actually bought the building a year ago. Is that why?
Chris: That is an outstanding point that you just brought up. I mean, it’s just outstanding because so So many things get dismissed because people are like, oh the building’s 40 years old or all this was this as old as that. And the magic of this is that as you say, every time the title changes hands, you’re completely resetting the depreciation schedule. This is part of the Treasury plan. This is encouraging people to sell the real estate more often. Because every time real estate sells it usually gets upgraded remodeled, something is done to it. And so I’m going to make a statement with a lot of people will argue with and there are reasons to but if you own a building for more than 10 or 15 years, you’re very likely losing money on it. Because you have depreciated so much of it. Now if you have this building and your dry-cleaning company is there in the corner of fifth and buying a you need that building to run your business, this doesn’t matter. But as an investor, do you really care I mean, you’ve got a 30-unit apartment building Sell it and buy a different 30 unit apartment building, you’re resetting the basis, you want to own things for a certain amount of time to maximize this. And then when you’re doing subrogation, you can maximize that benefit in a shorter time. Now, there’s other rules that go along with this. everything I’m saying is a little bit of a soundbite here in this format, I know. But absolutely, the title changes hands. And then this, let me give you a little side issue here. We sometimes we have apartment or have struck shopping center or whatever, and they’ll have partners in an LLC. And then a partner will leave and another partner will come in and buy them out. Hey, that doesn’t do any good because they’re not changing the LLC continued to own that property. The partner changing and buying in and out of a member units in the LLC does not have the title change hands. Right, right. So that’s another aspect to this as you want to really. And so the way I would say is an easy way to think about this. If you’re interested. And you’re using a good old fashioned taxi, bunch of gets in the taxi. The meter flag goes down, guy runs around town, gets out, the flag goes up to lunch and pays. Chris gets in, the flag goes down again. The taxi is just like real estate. It is a vehicle. And every time a new person gets in that vehicle, the flag goes down, the flag goes up when they get out. it resets every single time. That is the beauty of right now. That’s amazing, right so the rope example in your calculator $10,000 based on 30 personal income tax bracket. So if the brand new roofer costing me 30,000, they’re really costing me net net 40,000. So, so by replacing those rules, I actually save 20% right off of MSRP. By doing that, I had the study done, and that would be the same thing for a duplex receptacle. If you bear with me, let me give you a really simple small example of this Okay, and your listeners are not going to be managing the property. But it would be good for them to know that if you are managing this property that this can be handled this way, a duplex receptacle a regular plug in the wall 110 volt 1520 amp receptacle is going to be worth about $125 new construction cost with the labor the wire, receptacle, the box that it goes in, etc. So let’s take $125 divided by 27.5 and that equals $4 and 55 cents per year. Now let’s say that after five years somebody comes in or it’s the favorite plug with a toaster and everything else in the kitchen and it’s arguing it’s no longer grabbing the plug that’s going into it whatever. So you have your maintenance man, punch in what would it cost you’ve got a maintenance person with a laundry list of all kinds of stuff. Not just an electrician that drove there to do this one thing would have cost you for your maintenance person on their list of things in the day to go and replace one duplex receptacle. All these have to go there and leave and he’s got his truck and he had to go buy it in Ohio. Yeah, an hour. So it’d be like, $30 there’s going to be the invoice or something like that.
Chris: Yeah, I mean, you know, if you’re downtown New York City, it’s going to be $300. Right? That would be a bargain for the union electrician in downtown New York City could be $3,000. And that’s fine. But you know, it’s just, we’re just picking numbers here. That might make sense. Okay, so we’re going to say that you’re going to get an invoice for $30 for replacing one duplex receptacle. Now we’ve got $4 and 54 cents per year. So after five years, we’ve got 22.5 years left, right? Yeah. So, times 22.5 that equals $102. So there’s $102 in tax life left. Now we said 30% ordinary income rate. So let’s take 102 times point three. Okay, so we have $30 and 68 cents. Now, just like in the magic show, right? You and I did not talk about this ahead of time right now, huh? Okay, this is just a came out. And I have some suspicious people on this because you just said it costs $30. And I just came up with $30. Right. So I want to see if the listeners can wrap their head around this because this is a little bit difficult to think about, but when you get an invoice punch in for 30 days. I say that it almost never cost you what it says on the invoice. And everybody I hope is really, really listening to this carefully, never really cost you what it says on the invoice. So in this case, it cost you either nothing, or it cost you $60. Right. Exactly. And that’s really hard to think about because you see this invoice $30 I pay $30. And then other people come back with an argument. Oh, well, my CPA would expense that. Yes, yes. Yes, your CPA is going to expense the $30. No question is the maintenance item. We’re not talking about that. We’re talking about the money that you have imbedded in the thing that was thrown away. That’s the distinction here. And you’re going to expense it going forward. So, it’s a win, win win. Right? But then the other pushback you’re going to get is Oh, that’s ridiculous. I’ve never cost more and bookkeeping to keep track a little stuff like that. I don’t know. No, because when I do a study, I put everything in a generic Excel program. So now it’s fully searchable. You can see everything that’s in there. And it’s not a problem to keep track of this stuff, you let the machines do the work, don’t come in with a, you know, a big box full of receipts. Right? And if you have a regular maintenance person or Pancham’s company that they know how to use Excel, it’s simple. They just load this stuff in as they come and go. And if you’re going to do something, or is going to think of remodeling something, hey, call Chris. No problem. There’s no ongoing cost. Once I’ve done a study, it’s fully supported ongoing. Right. So if you have questions, is I’m thinking about replacing the rugs. I’m thinking about luxury vinyl tile, I’m thinking about this. I’m thinking about that. Okay, punch him. Well, what about the luxury vinyl tile that’s going to wear a lot longer. It’s not going to be a problem with mold and you know, people spilling well. Are you going to leave it floating? Are you going to glue it down? Well, if you glue it down, it’s going to be a 27.25 year item. If you leave a floating, it’s going to be a five-year item. And under the 100%, bonus to five, your item will be a one-year item. So I don’t want people to have to remember this. All you have to remember is I’m the guy that sent it.
Pancham: That’s great. You know, I have so many other questions, but I want to be respectful of your time as well as you know, want to cover my next section of the show. Do you want to add anything to this thought before we move on to the next round?
Chris: All I would want to say is that from what I have seen, and I am not a financial planner, but I see an awful lot of that and I work with a lot of people with their overall financial plan in retirement portfolios, I don’t believe I’ve ever seen anything which is even approaches 5% in an investment portfolio that’s in real estate any version of real estate Toll Brothers stocks reaps anything, right? So when 70% of the US economy revolves around real estate, it just doesn’t make sense to me. And I’m not advising any particular person, it may make sense for somebody to have nothing but bonds or nothing, but whatever, that’s between them and their financial advisor. But when I see, you know, literally hundreds of financial plans over the years, and almost nothing in terms of real estate and 70% of the economy revolves around real estate. That doesn’t make sense to me. Now, whether your portfolio should be 50% real estate or 10%, or whatever. That’s not a discussion I’m having. I’m just saying that real estate is unique capital asset that allows you to depreciate it while it’s appreciating it’s 70% of the US economy. And stockbrokers and people in that business. Don’t sell that and I have had many broker dealers and other people they don’t they don’t even talk to their clients about that because they can’t sell it. So you have to be astute in your own mind and decide how you want to go about this. And if you want to invest in real estate you want to professionally managed, you want to have somebody who’s paying attention to these details and they have the right system of Accountancy in order to maximize the benefit of this type of asset.
Pancham: Right. Thank you, Chris, for that. We will be back after this message. Have you ever wondered why the rich keep getting richer? What is the secret that they know but you do not? What if I told you that wealthy people make their money work for them into different places? Yes, the same dollars invested into different places and working hard for them while they sleep. They utilize these special accounts that have been in existence for more than hundred years. Do you want to learn more about these accounts, then you are in the right place? Listen to the episode number five by going to the gold color. investor banking.com forward slash banking show I repeat the gold collar investor banking.com forward slash banking show or visit the gold collar investor banking calm. Alright, let’s move on to the next section of the show which I call taking the leap round. And I asked you for questions to every guest on my show. So my first question for you, Chris. And when was the first time you invested outside of Wall Street? Would you say that the first business that you own at 17 years of age,
Chris: Right. When I was 17, I was in college I had to figure out a way to put myself through college so i i started a small real estate maintenance business which was basically just fixing broken windows, door locks, loose hinges, leaky toilets, faucets, and then twice a year I would be moving students in my pickup truck and any way I could find to make a little money. I was out there hustling taking out the trash. This was back in the day before we had done Here’s where you actually had to take the trash cans to the curb. And so I would go three o’clock in the morning before the magnets got up and take all the trash cans out to the curb. And then I go down to the white YWCA and take a shower and then I go to class and then after class, I come back in the afternoon and bring all the cans back and then they go back to the why and take another shower. Because I keep my clothes for the work clothes here because it smelled so bad. But But anyway, that’s really how I started out just being a fly on the wall watching slum lords and other people with the way they operated and the different kinds of people that were there and immense back in the 60s and you know, you’d knock on the door maintenance and then you open the door and then somebody laying on the floor with a needle in their arm. Okay, I’ll come back later. But I got to kind of a rough start to real estate works but you know, I just spent my whole career in the out in the field working with various types of property and as bestest and cleanup of PCBs and radiation and all kinds of things. I’ve always been out inspecting and testing and working on the components of building so I really enjoy that. I really like to be out in the field seeing what people do like. I can tell you how marble slab Creamery works, how a McDonald’s works, how a Taco Bell model. I mean, I have a fantastic job. I get to see every conceivable ABC molding factory boatyard hotels, just all these amazing kinds of businesses and how they work just being there every day, looking and walking around and taking notes and pictures and doing these studies. It’s just a great job. Right.
Pancham: That sounds exciting. My next question is what fears that we have to overcome when you first invested outside of Wall Street? Did you have any fears at the age of 17?
Chris: Yeah, starving to death. And when I first started my business I had absolutely no money and I was sleeping in the back of my little van with a under a drop cloth and going to the why to get showered and get ready and try to put myself through school and no it was you know I get dressed up in my little suit and my cheap shoes and go out and pass out little business cards and I tried to drum up business but the slumlords were really eager to get somebody that would do all this diddly little stuff because they could get contractors to remodel the kitchen or do but they didn’t have somebody to do all these little things. And nobody wanted to take out the trash. So I find myself a niche business doing everything too dirty or too silly or too dangerous for anybody else.
Pancham: Right now, that’s good. All right. My third question is can you share with us one investment that did not go as expected in terms of real estate, it’s difficult to say there are a lot of people having problems with real estate right now. And some of my customers, I mean 10 hotels are shuttered. There’s nobody staying in hotels. So there are some unexpected things. And I would say the lesson there is conservative, get your money back as fast as you can. That’s what I do is I get people their money back back in their hand as fast as possible, because predicting any investment out five or 10 years, it really trails off in the reliability when you do a test punch them there’s two factors to a test. So people will take your temperature or they’ll check your blood or they’ll check you know, what is the level of radiation or what is the what kind of grass is growing on your lawn, whatever it is. You may do a super, super accurate test, like the microscope, the certification, the training of the people, the calibration, all of that’s perfect, but there’s another factor with test. The other factor is order of confidence. So you can have a very, very accurate test, but the order of confidence can be extremely low. So if I go out on my lawn and I take one foot square sample of the dirt, and I test it, I may get an extremely accurate test. But if I’ve got an acre, what is my order of confidence that the whole lawn is actually the same as that it’s very, very, very low. So as you go forward in time, your order of confidence in your prediction gets lower and lower and lower. So with my clients, I’m always working to maximize getting them all the money in their bank back as fast as possible, getting all the deductions so to speak in their bank as fast as possible, and then they can spend them going forward more on their own schedule.
Pancham: Got it. Got it. Okay. My last question is, what is one piece of advice would you give to people who are thinking of investing in main street that is outside of Wall Street?
Chris: Well, you’re not going to be managing it yourself. If you’re talking about multi family, you need to have a very good manager and I know Pancham is a very good manager so I, I’m definitely promote him know him I know what he does and they have a good system for taking care of that. So that’s really, really important. And then, you know getting control over every detail in that property if you ran a bread and milk and cigarettes and gasoline store, you would know every single bar of ice cream gallon of milk, whatever that was on your shelf, what it cost you what the shipping was, etc. But real estate, they just kind of run it like it’s a lump and all Geez, there’s still money in the checkbook, we must be making money. Well, that’s not the way punch him right? That’s not what I set up to be able to do it. So I’m setting up this framework of a system of Accountancy so that real estate can be managed in a truly granular level. That’s what you want. You want accountancy you want documentation you want control. So that’s really the point. I mean, I deal with hotel customers, and they literally can’t tell me what is the cost of water per, you know, two-bedroom, double-queen, whatever. They can’t tell me how much water is in the hundred dollars or whatever they charge people for staying every night. The old people use the water but they don’t know how much water I think drives me nuts, though that level of pasta understanding is super important. And then it starts things start to go wrong, you know, you’re not charging enough money. You don’t need to find out, Oh, geez, I ran out of money. I must not be charging enough. You can find out that you’re not charging enough way before the wave hits. You know, they’re trying to flatten the curve. Well, I’m trying to get ahead of the curve. Right. We want to get ahead of the curve. I don’t know what’s going to happen before it happens. I kind of have a joke with people I say look, I’m an engineer. I like to plan all my disasters well in advance.
Pancham: Great Thank you, Chris. This has been great. You know, if someone wants to reach out to you and learn more about you or your business, how can they do so?
Chris: Well, I have an email. I don’t want to do the web. I mean, if you email me or call me, let’s just talk about it. I’m old fashioned. I don’t text. So, I my email is Chris WCHR. I as W, the number five, the letter X number email@example.com, Chrisw5x5@gmail.com. Great. If any of you were in the, you know, the Army or the Marines read you five by five…five by firstname.lastname@example.org and then my phone number is 8652209002. I am on Eastern time. I know I really want to find out what’s going on for each individual person and to see what is the benefit of this for that individual person, Grant.
Pancham: Thank you, Chris, for your time today. I’m sure this is very helpful for people who are thinking of doing class segregation standing and thinking about that they’re leaving money on the table if they’re not doing so, depending on individual situations, of course, right. The government wants your money. They want you to manage the money on the ground level. I mean, I know the Treasury people and very bright career PhD degreed economists, and they understand that the government is the worst recycler of money in the economy. This is not slamming the government, any government. matter where in the world is the worst recycler have money in the economy. The United States government realizes that the people that are on the ground spend the money more wisely, more broadly and more effectively than the government can. So this really is a government program that serves everyone in the United States of America. And it’s, it’s a very good patriotic program, which the US Treasury was brilliant in creating it. Okay. Thank you, Chris. All right. Thank you.
That was a lot of information. And I know Chris, like you mentioned that if you ask him time, he will start telling you, you know how the watch works. So if you feel that it was too much detail, so I apologize for that. I hope you learned a few things by listening to this show. It may feel that it is overwhelming, but I assure you that it will be well worth spending time on tax planning. I would end up by saying this tax is your number one expense. Real Estate Investing can play a big role in helping you reduce your tax expense. Thank you for listening. I appreciate you for tuning in. If you have questions email me at be at the gold color investor.com that’s email@example.com. This is Pancham signing off. Until next time, take care.
Thank you for listening to the gold color investor podcast. If you love what you’ve heard and you want more of Pancham Gupta, visit us at www.thegoldcollar investor.com and follow us on Facebook at The Gold Collar investor. The information on this podcast are opinions as always, please consult your own financial team before investing