Ep 75: Real Estate Tax 101 – Cost Segregation and Bonus Depreciation

Mitchell Baldridge is both a friend and consultant of mine, and he joined the podcast to discuss cost segregation and bonus depreciation, two huge tax advantages that make real estate such an attractive investment option.

So what is cost segregation? Simply put, it’s a way to understand every component of large business purchases. When you get gas for your car, you can easily write it off and deduct it as a business expense without much thought. But when you make a bigger purchase, like real estate, the IRS dictates that you have to deduct that expense over a certain period of time. Different assets have different timespans; the useful life for a self-storage facility is determined to be 39 years, which means every year you can write off 1/39th of the purchase price.

Realistically, not everything in the building has a 39-year lifespan, and cost segregation helps you break down the useful life of each component of the building. Windows may last 15 years, locks on units may need to be replaced after 5 years, etc. For just a couple thousand dollars, a cost segregation engineer from Mitchell’s company will come to your property and break down your total purchase price by the different components and their lifespan.

So why do you want to pay Mitchell’s team to come to your property? Let’s say you buy a $1M self-storage facility, which would typically carry a write-off of $25,600 each year for 39 years. When you segregate expenses, Mitchell’s team can usually bring 15-30% of the purchase price into what is called accelerated depreciation. Every component of your property with a lifespan under 15 years is bucketed into one group, and the IRS allows that to be deducted from your taxes in year 1. Instead of writing off $25,600 your first year, you’ll be writing off $150K-$300K, and that property may effectively act as a tax loss in that year. This is how real estate investors avoid taxes by offsetting their other income with bonus depreciation from new properties. You’re effectively creating a deferred-tax liability, which acts as an interest-free loan from the government, which is a no-brainer considering the cost of debt.

At Bolt Storage we bought a property for $3.8M with 30% ($1.14M) down. Mitchell’s engineers evaluated the property and valued the land at $1.1M and the physical components at $2.7M. Land can never be depreciated, so we were working with the $2.7M in our cost segregation, which would normally be deducted at $70K/year over 39 years. Mitchell’s team deemed that $1.1M of components on the property had a lifespan of 15 years or fewer, representing 28% of the purchase price. We could write that off in the first year, creating a huge tax saving for us.

This perk is even bigger if you’re considered a real estate professional, which is a tax designation for those that spend over half of their time working on acquiring, constructing, or managing real estate. Real estate professionals and their spouses can use these tax losses to offset regular W-2 income!

Frankly, the government wants to incentivize people to build, buy, and maintain houses and facilities, and this is where the tax incentives come from. The amount that can be deducted in year 1 varies over time, and recently rose back to 100% with the 2017 Cares Act. It’s scheduled to taper back to 80% in 2023 and eventually down to 20% over time, but it’s something that will always ebb and flow with Congress.

It’s important that you find a CPA that works for you, and that’s why I’m so glad I came across Mitchell. I’ve employed 6 CPAs in my life, and 5 of them acted like they worked for the IRS. They didn’t want to cost segregate, bonus depreciate, or take legal advantage of the tax code. Mitchell is the first one that has acted like he works for me. He’s prepared for an audit, he’s acting within the lines of the law, and he’s trying to get me the most that he can.

So should you cost-segregate every property you acquire? Maybe, but properly not. It doesn’t make sense to cost segregate if you plan to flip the property in a few years it probably won’t make sense when dealing with capital gains and recapture tax. Otherwise, if you’re looking at holding for a longer term, it really is a no-brainer for a real estate professional.

If you have questions for Mitchell for the next time he joins my show, email a short audio clip or paragraph to me at [email protected] and we’ll answer it on my show. You can find Mitchell and his team at the following sites:



Twitter @RECostSeg

Twitter @BaldridgeCPA

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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.