Podcast Episode 114 Transcript

Episode 114: Cost Segregation Made Simple With Joseph Viery

Are you ready to bring your real estate game to the next level? My name is James Prendamano. I'm the CEO and founder of Prereal. And over the past 25 years, I've closed over a billion dollars in transactional real estate. Each week, I'm meeting with outstanding and investors, highperforming individuals and visionaries operating in the real estate space. These are the people that are actually out there in the real estate game right now getting it done. This podcast aims at bringing anyone's game to the next level. This is the prereal podcast. Welcome everyone, to the Prereal podcast. We're joined today by Joe Viery. He's the founder of USTAGI and he's a cost segregation specialist. Timing couldn't be better. Cost SEG is something that I think is going to play as prominent of a role as it has always played. I think it's going to play an even more critical part in the CapStack and evaluation of deals as things continue to change at a rapid pace. Joe, thank you so much for taking the time and joining us today.

No, James, thank you very much for inviting me. Look forward to it. Yeah, so look, we're always looking to deliver value where we can for the audience and see if we can connect some dots for them and to look at things from a little bit of a different perspective. So I thought the first place to start is in your own words, could you explain to the audience precisely what is cost segregation?
Precisely. Wow, okay, I'll try my best. So, to be precise, basically, cos Seg deals with the world of depreciation. Depreciation is an expense against income. So I don't think you need to have somebody very well acquainted with accounting to understand that if you have income, you can reduce your income, your taxable income by your expenses. So what we do in cost segregation is we're accelerating the depreciation expense on the building, which reduces your taxable income, which increases your expenses, reduces your taxable income, and therefore it reduces or eliminates income taxes. So I have my clients call me up because like right now, today is the d day. But thank God it's almost over. Where it's a deadline. September 15 is the extension deadline for those who have extended their taxes for their entities, meaning LLCs, LPs, corporations. And so basically, I have people calling me up saying, hey, I owe money, what can I do? And this is a legal compliant approach to increasing your depreciation expense.
So what type of asset classes? I know you've been involved literally in thousands of transactions. So how wide of a spectrum are we looking at here? What type of asset classes would qualify for Cos SEG? This is a great question, James. Basically, and a lot of people don't, there's a lot of misconceptions. And this is one, any type of depreciable building not appreciable because obviously your residence is not a depreciable asset. So don't call me about a residence that you live in, because that's not a depreciable asset. But any type of investment property and land, of course, is not depreciable. So any building we can effectively accelerate the depreciation on. And like, I've had some people go, wait a minute, I own a warehouse. It's four walls in a roof. What the heck did you accelerate in a warehouse? But we can find a lot of items in a warehouse. Another one. A lot of people don't think about our mobile home parks. But why? Because we also deal with the land improvements. So we're accelerating land improvements as well as the interior personal property of the building. So it's a kind of a very complicated part of the tax code. And to be honest with you, a lot of accountants don't even understand it. They don't get it. And that's the reason why a lot of people still to this day don't understand or know about cos SEG, because their accountants take the easy method, which is simply straight line. And I can have a five year old, six year old, or maybe a smart animal do it. All you need to do is take your building basis, which is what you paid for the property, less the land divide by either 27 and a half years for residential or 39 years for commercial. But it doesn't take a brilliant person to look at you're taking that expense over 40 years. I give it to you today.
Okay. So a lot of ground to cover there. So don't call you about the home that you're living in. A thing we've seen emerge over the last few years are the funds are taking down, and now a lot of the smaller investors are taking down large packages of one family homes treated as investments, certainly not primaries. Does that qualify?
Yes. Okay. Can I give you a caveat now, or do you want to continue? No, go ahead, please. Here's the caveat. I started in the industry in 2007, and when we started, there was a document that came out a couple of years earlier, three years earlier, which is the audit technique guidelines that's published by the IRS, that if you have a reputable firm, that's our bible. We take those seriously, and we do everything the way the IRS wants us to do it. So for years, we did the engineering approach, the engineering the detailed engineering approach, which we still do a lot of today, means we go out to the property, we document the property, meaning we take pictures, we measure all the building components. The engineer goes back, and he does the take offs, the calculations, and we deliver the report. Well, think about it. The expense of flying somebody all over the united states is not going to work for a single family home. So we recognize that, and the IRS recognizes that we can do another type of model, a type of study. It's called the modeling study. And so what we've perfected over the last six years is called modeling where we can now do an analytical study. We use our database of tens of thousands of past studies and buildings and we basically can use Pictometry software. Which is satellite software. And we get as much information as we can get our hands on and we can do an analytical approach which basically tells the IRS okay. You have a single family home in this zip code in Alabama. This size of a property in this big of a lot and we can give you a report. That type of report is hundreds of dollars and therefore it's very affordable. So we do both the big buildings, up to 500 million is the biggest I've done up to $80,000 single family home. Wow. Yeah, technology just continues to open up so many doors and disrupt so many industries. As we talk about the asset classes and identify essentially it's any improved property that's an investment, right? Can we define improved a little bit more? Let's say I have a piece of vacant land and we've done underground work, we've done sewers, we've done septic, we've done water lines, we've brought in electric. Does that qualify or does it have to be ground up vertical? It doesn't, but that's a pretty rare exception. Meaning that could I do it? Yes I could. Because land improvements are 15 year property and we can accelerate the 15 year property. Of course. But then we have to look at what is involved because if I have to send somebody out somewhere to document the land improvements. I might not get that much bang for the buck because what we do is mostly a combination of building improvements. Which is personal property. The five year property inside and the land improvements. But the answer is yes. I have done properties where it was only land improvements, where they came in there and they did drainage, they did water treatment, they did ponds, they did roads and of course a lot of that is very valuable to accelerate. So does it matter if the assets are in QOZB, an opportunity zone or if it's a 1031 exchange? Does that make you eligible or not eligible for any of these benefits? Another great question, opportunity zones. No, that is just going to increase your tax benefits that you're already getting from an opportunity zone. So the question would be when you want more tax benefits, not less. So yeah, I have a lot of opportunity zone clients who acquire opportunity zone properties and then do the cost SEG on it. The other part of your question was 1031 exchanges. Now I'll call it the Trump tax law that happened a couple of years ago. It did present a wrinkle in 1031 exchanges. But I will tell you this to make it really simple is I've had no one who has not done a cost segment because of the impact of 1031 exchange. It gets a little bit more complicated for us to illustrate it. And the reason is I think it's simple but maybe it's not. The reason is it's simple if you 1031 exchange a property and you acquire a new property, what you brought over from the relinquished property and it's most always going to be straight line. Straight line then is forever frozen. I can't accelerate that. So you have to have something for me to accelerate. Otherwise I'm going to tell you don't pay me money because I'm not going to give you much benefit because you're frozen. You're locked into 27 and a half years, 39 years because you didn't do the cost on the property you relinquished. So that can happen. But most of the time what people do is they upgrade the property. So it's not like they're selling a million dollar property and buying a million dollar property. They're selling a million dollar property and buying a $2 million property. Well I have a million dollars to work with so then yes, it makes sense. Okay, so that would really tie in to the Qozb's, right. In the Opportunity Zones we have significant holdings in states outside of New York because New York decoupled from the Opportunity Zone benefit, the federal benefit. But let's say we have a property that keep the numbers simple here. Let's say it was a $27 million property or improvements straight line. I'm sorry, $39 million building for commercial straight line it would be a million dollars a year that you're able to depreciate and you're kind of locked in. Now with the Opportunity Zones, we're essentially getting a 10% discount on our capital gain and that depending on when you identify this qualified money. But let's keep it simple. In 2026 is when the tax man comes looking for payment. And one of the key kind of Cornstone principles of the Opportunity Zones is you have to be improving the property, right? You have to be creating jobs and you have to be improving the property. So we're going to take a building and we're going to extend it, we're going to rehab it, whatever it is, we're going to hit that two to one ratio. And come 2026 we know that we have a big tax liability that we're going to be faced with. Are you able to stack and structure the depreciation in different increments yearly? In other words, do you get to play with it year by year? Can we back load it to 2026 or? No, no. Okay. What you could do is you could do the study in 2026 or whenever your tax obligation is due or as you know, losses carry forward so you wouldn't have any disadvantage by producing the depreciation expense. If you don't need it, it just carries forward until you do need it. Okay, so we could theoretically do the cost egg study in 2026 knowing that we have that burden and that would help us generate these losses to offset what needs to be paid in that calendar year. Correct. And one thing you mentioned, too, is that it's a multi phase project you're talking about. And unless you have a cost tech firm that kind of understands and has the experience, why I say multi phase is because what we do is we will look at the acquisition of the property. That's a separate total. You bought a property for X, and we have a building basis of X, and we do our work on that. Then you've got the improvements. That's another phase of the property. So I'll just throw out a number on the $39 million property. Let's say you spend I'll make it up $5 million. Then we will go and revisit that $5 million, and we can accelerate that. Also, there may be although this gets a little tricky, and I'm not an accountant, so I'm not going to give you accounting advice, but you may be able to take dispositions on the property that you dispose of when you do the improvements. However, that technicality, that code in the IRS is very tricky, and it's beyond my capabilities to give you an answer. But there may be a possibility to expense those items. And one of the values of having a cost segregation study done is you now got the line items for every part of that building. So if you throw away countertops and you know how many linear feet of countertops you throw away, you have a value that you can now expense the year you throw them away. However, the expensing rules get really complicated, and it may not be there. But even if it's not, you still have the accelerated depreciation component of cost segregation, which, again, is going to be huge. Wow. So, Joe, when do we get you involved in the project? When is the appropriate time to engage your firm to start doing an analysis? Well, here's how it works. We do a no cost estimate. So you just give us some answers to some questions, and it varies whether it's a look back study or a current year. In fact, let's talk about look back studies, because that's important. Because another misconception is, oh, I can only do cost on new construction. Oh, I can only do cost segregation the year I buy the property. Okay. I can go back to about 15 years when you acquired the building, not the age of the building. George Washington could have built the building. I don't care if you bought it within the last 15 years. I can go back. And you're probably going to get value out of accelerating the depreciation. Now, that's a numbers game. There's calculations that need to be done because you've taken depreciation on look back studies, so you can take it twice. So I'm going to accelerate your depreciation. I'm going to have to calculate how much you've taken, and then you're going to have to pay me a fee, and then I will have to decide, is it worth it for you to do cosseg on a building if you bought it 10, 15, 20 years ago? Most of the time 15 years is the threshold where I think it makes sense. And then you have the current. So if you do a look back study, you have a filing in your tax year, your last tax year, called the depreciation schedule. That's all I need. You give me the depreciation schedule for a look back and the address of the property if it's not on the depreciation schedule, and then I'll run an estimate at no cost. What do I do when I run the estimate? I will tell you after we look at the building, what we feel we're going to find, and then we'll look at how much engineering time it'll take to do the study, if it's an engineering based study, and then if it's a current tax, your property, you don't have a depreciation schedule, the last thing your accountant wants to do is a depreciation schedule. They wait, probably there are some accounts doing depreciation schedules today for our filing today. They wait until the last minute. So therefore, what we do to get the ball rolling is all I need is the answer to a couple of questions. One, how much did you pay for the property? Two, what date did you place it in service? Three, what's the address? And then there's actually the fourth one, which you mentioned. It wasn't involved in a 1031 exchange. If it was involved in a 1031 exchange, then I need to see the exchange documents so I can back out what you're bringing in from the relinquished property and take that off the table so I don't estimate a higher figure than you're entitled to. So once we do, we get all the information, we provide you with an estimate, we provide you with the fee. And then what I suggest the client does is talk to their accountant and say, hey, does it make sense? We don't care if you say yes or no. I mean, we're happy to give you the estimate. We're really good at what we do, and if it works for you, great. If it doesn't work for you, then maybe next time. So it sounds like anytime up until 15 years in and even at that point you can go back as far as 15 years is an appropriate time to engage. But are you finding our folks engaging you at time of acquisition or just before acquisition and modeling that into the Capstock? I've done it every which way, but yes. If you want me to tell you my dream, my dream is when you acquire the property, you get in touch with us because there's a lot of advantage of doing it sooner rather than later. There have been some cases where they've done it later and I still pull the rabbit out of the hat, but I like to tell the investor, call me as soon as you acquire a property. Let's touch base and let's decide when is the best time for you to do it. Because if it's a value add property and you can take dispositions, I need to document that property before you start ripping things out. I don't make stuff up. So I got to see if you're taking out countertops. How much are you taking out and what kind of countertops are they? Are they tile or are they laminate? And so bottom line is, it just depends on a lot of questions. But call me as soon as you acquire a building, reach out to me, and then we can discuss what your options are. So how does this affect? How would it play out? A lot of syndicators around a lot of folks that are in as LPs that are not really running the deals, but they're in a passive way. Do you have the ability to do that in a limited partner role, or does this have to come from top down? How does that work? Well, it's complicated, and that gets into tax advice. And again, I'm not going to give you any tax advice, but I will tell you that syndications do perform cost segregation. You mentioned the one word that is a problematic word, and that's passive. I have a lot of passive investors that do cost SEG, and I do not talk to their accountants about how they're applying the cost segregation. But I know that it does work for many passive investors. But that being said, what I would do is I would take these passive losses to your accountant and say, okay, I've got passive losses. How can I use them? Because there are a whole bunch of rules to passive passive income, and I'm not capable of answering it because every situation is different. But I will tell you that we do have a lot of passive investors and syndicators are doing a lot of cost segregation. It does work for them, for sure. And is there any increased risk of audit if you're doing Costa, does that impact the IRS? When I started in 2007, nobody even could pronounce cost segregation, let alone spell it. And the first thing I got out of everyone's mouth, oh, this is too good to be true. There's no way. This must be a scam. And, oh, I'm going to get audited because this is a scam. Blah, blah, blah, blah, blah, blah. Those days are over. They are gone. The IRS recognizes that cost segregation is the way to depreciate a building. If anybody has a building right now, they're in. And they look down at the carpet on the floor, and I asked them, will that last 27 and a half years or 39 years? They would say, Are you crazy? Heck no. And so the IRS has literally hundreds and hundreds of building components that they agree can be accelerated. So we're doing it the right way because the IRS recognizes that carpet and all types of building components need to be accelerated. So the day of being audited now what you might be audited on is another circumstance in your tax return. They may look and see you've done a cost segregation, and they may want to talk to me about my methodology. And we do that at no cost to the client. We defend our work because it's really kind of simple and it's really a good thing for us to do because we like to talk to the IRS. We explain our methodology and they ask questions. And then at the end of the day, they say thank you and goodbye. But if you get somebody who doesn't know what they're doing, or you get somebody who's working out of their garage, or you get a new entity in the business, I would say give everybody a little silent warning here. I don't know if everybody knows this, but there is a lot of money going to the IRS. And what are they doing with the money? I think it's billions of dollars they're hiring. And who are they hiring? Part of that is agents. So we in the cost segregation industry that know our industry. We're expecting to be audited. I don't get audited at all, but I'm expecting more and more audits in the future. So it's just a mild beware. Work with somebody who will defend their work, will be there when you want them. Because I know companies who say they will provide audit defense, and then when the IRS comes knocking, they're nowhere to be found. We don't do that. We're happy to talk to the IRS, so get the audit offense. So could you talk a little bit about recapture and on a sale, if and how does this impact? Okay, so if somebody were to call me, one of the first things I would ask them about, we talked about, one, are you a passive or active investor? Then number two, I would ask them, how long are you planning on holding the building because of depreciation recapture? In my experience, I use a threshold of two years. So if you're going to be selling the property within two years, I will most likely tell you, keep your money, don't pay me. Because by the time you pay depreciation recapture, it's probably not going to pencil out. Unless if I give you a dollar today and your internal rate of return is 100%, then you probably will make the numbers work. But for most investors, I would tell them, don't bother doing it. Now, depreciation recapture is a little bit of a complex topic, but let me explain to you what some of our accounting partners are doing by doing cost segregation. Now you're identifying the five year property and the 15 year property. So let's say you hold the property for five years to make the math work. And in five years. What they're telling the IRS is, okay, we've identified the five year property. Now my clients sold the property. The five year property has no more value. It's like a laptop you bought five years ago. What's the value in the laptop that you bought five years ago? Maybe $0.03 on a dollar. I mean, it's nothing. They're making the same claim. So basically the five year property that we've identified goes off the table for depreciation recapture. Same argument for the 15 year. A third of the 15 year property goes off the table for depreciation recapture. So what I'm saying is a very high brow way to look at depreciation recapture. But I know some of my accounting partners, they're using this to great effect, which means the cost aggregation not only accelerates your depreciation, but also may be able to reduce your depreciation recapture. Pretty powerful, really powerful stuff. And again, as I think things are going to continue to tighten up and become more of a challenge, I don't know if there's ever been a better time to start adding some of these tools if you haven't leveraged them and you've only been taking advantage of straight line depreciation. I don't know if there's ever been a better time to round out the skill set, if you will. So we're talking about such a diverse cross section of investment technologies and from 500 million to $80,000, I assume that the fees are a function of the complexity and the amount that's unlocked. Is that how it works? Well, on the analytical approach, we do have a fee locked, but because they're listeners of your show, if they mention your podcast, we'll give them a great discount. Again, the fee is not thousands, it's hundreds of dollars to do the modeling and analytical study. On the other types of studies where we have to take a more detailed approach, what we do is we do look at the building and we have to figure out, okay, how much time? So I'll give everyone a range. It's hard to give a range, but because it depends on the complexity of the building, but anywhere around, I would say $1500 to $3,900 would be the starting point for a detailed engineering study. And again, it just depends. Sometimes we go to multifamily that have 40 buildings. They're huge. We have to look at all the different building types. We have to look individually. Well, that takes hours just to go out to the field to look at those buildings and then to look at the units and to look at the land improvements. So obviously, if we're talking a big building like that that has 450 units in it, then it's going to cost a lot more to do that type of study. But if we're talking about a simple eight door building, we're talking in the 3000 $4,000 range, which makes it very profitable to do cost segregation. And it appears that it's not just a historic look back and a snapshot in the moment you're taking into account or can take into account planned improvements if you're repositioning an asset. These things, I would think this would become a really important part of as you're developing your plan for your renovations. If, for example, you have the ability to depreciate x if you're making patches on a roof, or if you can accelerate the entire roof improvement, knock it out of the way in a year where, I don't know, maybe you sold a cell phone antenna off or there's some event where you had additional revenue we can weave into our planned improvements also correct. It's not just the building as it sits right. And weave is a good word because the advantage to take dispositions on assets is very tricky. But if you plan it right, and I'm saying plan it right and you must plan it right from the get go, the beginning, then there are ways to take dispositions legally. It's a complex rule, but what it takes is planning. So that's why it's worth getting on the phone to me before you pull the trigger and just say, look, I'm thinking about buying this value bad building. What do you suggest we do? And I might suggest, okay, here's the deal. Don't start your renovations in the first six months. Wait if you can, because if you wait, then you can make the argument that will allow you to take the dispositions. The one part of that rule means if you buy a building with the intent of going in there and ripping everything out, you cannot take dispositions. Basically, you want to make sure that you really think about what you want to, what your processes and strategy. Can you hold the building for six months without doing renovations? Can you try and make that work? And then after six months it doesn't work. So there's a lot of factors where it would make sense to get me on the phone and just say, hey, look, here's the building, here's what we're looking at thinking about doing. And then I can give you tips on how I think it's going to work the best to maximize your deductions and reduce your income taxes. Okay? So wherever possible, I like to apply real time scenarios. It frames it for me and hopefully by extension for the audience a little bit better. So we're acquiring a shopping center now. Very good deal. 50,000 sqft plus or minus, paying $2.7 million for it. We know it needs improvements. We don't know the extent of the improvements. That's kind of part of the deal. You can't go in and really diligence this thing properly. There are a few tenants in there paying right now, but the majority of the center is vacant. What do I need? Do I need to have a full budget built out of potential repairs? What do I need to have this conversation with you so that we can have. An intelligent discussion on what needs to be done and the best way to do it in the next two, three, five years as we reposition it. Well, I think the first step is to get on the phone with me and go over some of the facts that you've already gone over for me to give you an idea of what I think a good strategy would be. It depends on the disposition angle is valuable, but it's not the end all. And it may not be worth it to try to take dispositions on a property. But I think it's worth it to pick my brain and get my feedback on how to construct this so that you stay legal. That you can take the dispositions since every building is different and you mentioned your building and all of that. I would say off the top of my head for getting the disposition angle. But I would just say you want to start by doing cost SEG immediately. Now, what does that mean? Immediately after you close, get me in there within 60 days so I can document what the heck you bought, and then we'll go from there. And then if there are other phases down the road, like you decide to start doing the renovations, I don't know when it makes sense for you to do them. Then we can talk about the second phase, which is going to be the renovations and how that's going to play out. A lot of times the renovations are over years and not over months, so you got to split it up over tax years. But I'm experienced. I know what to do and how to answer that question. So I would say the first thing is just get on the phone and talk to me. Let me know what you're thinking of doing, and I'll give you my opinion, and then you can take it back to your accounting advice or tax planners and see if they agree. So I have to ask, Joe, how did you get into cost segregation? This is a highly specialized field. I don't think people wake up as kids and say, one day I'm going to be a cross specialist. If they did, I'd be amazed, because no one does. It's kind of a unique story. I've always been in the entrepreneurial mode. When was at college, I went to San Diego State. I happen to live in San Diego, and when I went to college, while I was working there, I started in the travel industry. Make a long story short, I owned and operated a special interest tour group where I took entities like the San Diego Chargers and the radio stations, and we took them all over the world. Okay. Then I exited. I sold the business in 2000, and I segued into financial planning for the California Association of Realtors. While I was working with the California Association of Realtors, I had a guy who kept bugging me to learn about this new service that he thought that I should learn about. And I kept blowing them off because I thought he was probably talking about soap and so Amway or something. So finally one day I said, okay, Mike, let's go to lunch. Tell me about it. Well, I had clients that had a huge income tax issue, so I jumped on it right away. I saved my clients, like, $50,000 in income taxes. And then that was the year 2000, and everybody knows what happened in the year 2007 and eight. The car went off the cliff. The California Association of Realtors Membership, those that were left, certainly weren't worried about investing. They were worried about paying their rent and buying food. And I did the cosmetics, and the owner of the company called me and said, hey, you're really good at this. Why don't you come and work for me? And I said, yes, that's a good idea. So I started in 2007, and I was not slow when I started, because what I found in 2007, I was able to attract a lot of investors that had cash. So while the rest of the real estate market was crashing, what were they doing? They were buying. And guess what they were buying? They are buying properties that spun off a lot of taxable income. So I was very important to them. So I was not slow from day one, and it's gone straight uphill for me. I've been very fortunate and lucky, and I will be the first to admit that what happened, because doing what I do, the amazing part is that what do I do? I'm giving people money. I'm giving them cash flow. I'm allowing them to buy more real estate. I'm allowing them to go to Europe. I'm allowing them to pay for their college education, for their grandchildren or children. So it's a great industry to be in, and as long as you know the rules of the road and how to do it confidently, I love what I do. So I started the show during Covid, in large part because there's no courses for this stuff in school, right? There's no financial literacy programs. There's nobody out there that's pointing you in the right direction. And we felt that if we can make these connections and start building a better network exactly what you had just said. And not that this is 2007. Although it may very well become that in short order. I do think that this is a hell of a time to start finding ways to pull out what you can. Where you can. And when you can. Because this will be. In my opinion. The greatest buying opportunity in my lifetime. In 2007 8 9 10 presented some unique opportunities. But this is fascinating stuff. What does the USTAGI stand for? US. Tax Advisors Group, incorporated. So you can find this either by USTAGI or if you want to spell it out, US Tax Advisors Group, Incorporated. But Ustagi, as you mentioned in the beginning, is perfect. I like short and sweet. What's the best way for folks to find you? Go online in www.ustagi.com and they'll get my email and they'll get our telephone number, contact number, and that's the easiest and the best super valuable stuff. Joseph Viery. U-S-T-A-G-I thank you very much for joining us today. This was great, james, thank you. You did a very good job. I appreciate it. Thank you. Appreciate you as always. Everyone out there, please stay safe.