How real estate investors make millions each year but pay almost nothing in taxes

Hey Reader,

Many of the wealthiest people in our country earn millions of dollars per year and pay almost nothing in taxes.


They invest in real estate and utilize “depreciation” to offset their cash gains from real estate and other businesses. I personally made a good amount of money last year, but ended up with paper losses of over $1 million on my tax return.

You don’t have to be worth millions to utilize it, however. I personally got a cost segregation study done on a small rental house I own in upstate NY and was able to carry a sizable loss from that single, small transaction.

I’m going to explain to you how it works and also give a shout-out to the firm I use to do my cost segregation studies, Baldridge Financial. Mitchell (the owner) is my CPA and good friend.

Let’s discuss how it works:

Disclaimer: This isn’t tax advice and I’m not a CPA. Consult your own CPA to see if these strategies are right for you.

Bonus depreciation is the ultimate loophole and the main deduction big-time investors take to wipe away their taxable income.

Before we talk about the “bonus,” let’s talk about depreciation.

It is the act of slowly deducting the initial expense of an asset against your taxable income over the life of the investment.

For residential real estate, that is 27.5 years, and for commercial real estate, the time frame is 39 years. That means, every year, you get to take a “deduction” against your taxes equal to 2.53% of the value of a commercial asset and 3.63% of residential investment.


100% (value as a whole) / 27.5 (time frame) = 3.63% (depreciation per year).

Example: Residential building worth $100,000 / 27.5 years = $3.63k per year in a tax deduction, every year for 27.5 years.

This means, for residential real estate, each and every year, when you file your taxes, you can take a $3.6k deduction against your taxable income.


100% (value as a whole) / 39 (time frame) = 2.56% (depreciation per year).

Example: Commercial building worth $1MM / 39 years = $25.6k per year in a tax deduction, every year for 39 years.

This means, in commercial real estate, each and every year, when you file your taxes, you can take a $25.3k deduction against your taxable income.

This is a big deal. Here’s how it works in practice.

Let’s say you buy a $1MM commercial real estate asset that generates $60k of net operating income each year (6 cap). You can deduct $25,641 (2.56%, or 1/39th) from your taxable income each and every year for 39 straight years.

That makes a SIGNIFICANT portion of your income each year shielded from income taxes—42%, to be exact. POWERFUL STUFF. How many W-2 employees do you know that get to keep 42% of their paycheck shielded from income tax?

It’s time to discuss something called a “basis“.

The basis is the amount, in dollars, of your capital investment in a particular asset for tax purposes.

If you buy a property for $1MM, your basis is $1MM. But as you deduct things like depreciation, or any of the other tax deductions in this section of the course, your basis drops.

If you put a new roof on a property, your basis goes up. If you buy a neighboring parcel, your basis goes up. Any capital investments you make in a property add to your basis.

Note: Capital investments are different from operational expenses, and can’t be deducted (entirely) in the year they happen. In the example directly above, each year you deduct the $25,641 as an expense against income, your basis drops down from the original purchase price of $1MM by the $25,641.

When you sell an asset later or wind down an investment, your remaining basis is what you can use to offset your capital (taxable) gains on the sale.

If you sell this $1MM asset for $1MM in year two, after you had taken the $25k in depreciation, your basis drops to $975k, so at that scale, you would have a $25k taxable gain:

$1MM (sale price) – $975k (remaining basis) = $25k (taxable gain).

Okay, back to depreciation. It goes further than the simple 2-3% “straight line” deduction every year against your taxes. You can accelerate depreciation over quicker time frames for different parts of the property.

Different parts of the asset can be depreciated on different schedules based on their “useful life”. Some schedules are faster than the 27.5 or 39-year time frame, so you can depreciate them faster.

For example, a sidewalk has a “useful life” as determined by the IRS of 15 years. So you can assign a value to the sidewalk and depreciate it faster, over a 15-year time span.

Land, or the dirt the building sits on, can’t be depreciated because it has an “unlimited useful life” in the eyes of the IRS. Even in the original $1MM example, the full purchase price can’t be depreciated because you have to assign a value to the land.

But the roof, road, sidewalk, fencing, walls, gates, landscaping, latches, flooring, air conditioners, pagers, curbing, and more can be depreciated much faster than 39 years because the tax code has different lifespans for those items.

Each asset has a depreciation “schedule” provided by the IRS. This is also called a “useful life”. Some parts of the asset are 5 years, some 7, 10, 15, etc.

You can assign a value, or a portion of purchase costs, to different parts to “front load” the depreciation. The goal is to get as big of a tax deduction as possible early on because a dollar saved now is a lot more valuable than a dollar saved 39 years from now.

“Bonus depreciation” is a special area of the tax code. It allows you to deduct a certain percentage of cost in the first year an asset is put into service. At the time of this writing, you can write off 100% of the value of anything that has a useful life of 15 years or less.

So the landscaping, doors, sidewalks, HVAC, latches, appliances, security cameras, gates, etc. A certain percentage, laid out in the tax code, is depreciable all in year 1. That percentage changes depending on the administration and the tax code.

For years 2015 through 2017 first-year depreciation for all the items on a 15-year schedule or less was set to 50%. It was scheduled to go down to 40% in 2018 and 30% in 2019 and then 0% in 2020.

But then Trump got elected, and he enacted the Tax Cuts and Jobs act. Moving this percentage to 100% from 2017 to 2023.

And the real estate folks had a party. Here’s why:

Real estate investors pay for an outside consultant to come in and set values to all of the assets on a depreciation schedule.

This is called a Cost Segregation Study. I get all of my cost seg studies done by my CPA, who also has a cost seg firm. Check it out at this link.

How much does it cost? For a residential rental property up to $300k in value, it can be as cheap as $1,000 to get this study done. For a $1 million self-storage facility it costs me $3-5k.

Back to how it works:

It is not uncommon to allocate 15-30% of the overall purchase price on a 15-year or faster timeline.


Just how powerful is this?

We recently purchased a $3MM self-storage facility. We got a cost segregation study done for about $3,500.

Baldridge came in and set schedules for all the individual aspects of the property. They determined that there were $700,000 in items on the property that fell into the 15-year or less useful life period.

Bonus depreciation allowed us to write off this expense in the FIRST YEAR. That is 30%!

The NOI on that $3MM facility is only projected to be $240,000. That means if we operate the facility for four years and it produces $240k in NOI each year, it would all be tax-deferred for the first three years.

These deductions from bonus depreciation can also offset income from other previously purchased properties in the same “income type”.

So if you have a portfolio of $12MM worth of commercial real estate and it’s producing $700k a year in NOI, all you have to do is buy one property each year to make virtually all of that income tax-deferred.

But even after the first year, you still get to deduct more depreciation on that other 70% of the asset over 39.5 years. So you can often offset cash flow from a $20 or $30 million portfolio by purchasing one property of about 10% of the value.

There is more.

The Cares Act, passed during COVID to give relief to businesses around the country, had a little token thrown in for real estate investors.

It made it so you can carry the passive losses from depreciation back five years to income made in 2015 onward. That means if you had a lot of real estate gains in 2015, bought a property this year, and took a big loss through bonus depreciation, you can go back and amend your 2015 returns and get a tax refund for the taxes you paid back then.

Also, in The Cares Act, you can use the new depreciation guidelines to CATCH UP on assets purchased in the last three years.

Meaning if you purchased a property back in 2017 and didn’t do a cost seg study and accelerate depreciation, you can go back and do that and amend your returns.

You read that right, if you bought a property in 2017 and haven’t done a cost segregation study yet, you can do it now and go back and harvest those losses.

And you can carry these losses forward into eternity to offset future earnings if losses are remaining after you’ve wiped out all of your income.

This is a beautiful thing for real estate owners.

Accountants don’t always like doing this stuff for their clients for one simple reason:

The more deductions you take, the more work they have to do to file your returns. If you ask your accountant about bonus depreciation and they respond: “I don’t recommend that, you’ll have recapture later and you’ll end up paying these taxes at some point.” Fire them immediately.

A dollar saved now is worth a lot more than a dollar saved later. Get aggressive with your tax planning and find an accountant who wants to work for you and not for the IRS. There are a lot of terrible accountants out there. I’ve fired crappy ones, and I’ve paid good money for good ones. I recommend the latter.

That’s all for now,


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About Me

I started the Sweaty Startup in December of 2018 because I believe the Shark Tank and Tech Crunch culture is ruining the real spirit of low-risk entrepreneurship.