Brian LeFever:
All right you guys, my name is Brian Lefever. I'm going to talk kind of fast. Cost Seg is a little complicated. I'm not going to dive too deep unless you guys want to. This is really an intro concept. It's really designed to be roughly thirty minutes long. Terri says we got to be on this twenty minutes. I can talk forever on this stuff so I'll stay on as long as you guys need me.
Brian LeFever:
My background, I'm a structural engineer and I'm the head of operations for a software company here in Denver, Colorado called Titan engineering. And we coded a platform called Titan Echo and we'll talk about our software. Originally, we coded it for CPAs because as I get you through this, there's an engineering component to cost segregation in the strategy that CPAs can't do, so their only alternative for helping their clients with this strategy would be to hire an outside consultant. So we started coding this years ago to be their back office engineer so they could actually provide both, well the two components that they can do and we'll do the piece that they can't do and I'll explain that as I go.
Brian LeFever:
That's kind of our background. You guys can interrupt me any time. I'm not looking at the chat, so somebody yell at me if somebody has a question, I'm happy to stop and slow down and say it over again. So I'm just going to jump right in.
Brian LeFever:
Here's an overview of cost segregation. When you buy a building, right? When you buy a building, you're buying both land, which is the dirt and the improvements to the land. The improvements to the land depreciate over a period of time meaning that the tax law says those improvements are going to be worth nothing sometime in the future. Again, assuming you don't make any improvements to it. The land doesn't depreciate because it's always going to be there, so we have to carve out a piece of the purchase price as land, we set that aside. What's leftover, we depreciate. If it's residential property, which it sounds like a lot of folks on here today, that's kind of your focus, that land or those improvements will depreciate straight line which means the same amount every year for exactly 27 and a half years. Don't ask me why 27 and a half, that's the lawmakers making the law, we just have to abide by it.
Brian LeFever:
If it's commercial property, whether it's industrial or offices or retail, they depreciate straight line over 39 years, so it takes a little bit longer. So that's ultimately without cost seg you are getting a depreciation deduction. A deduction is just it's a paper loss, right? You're not actually losing the money but for purposes of calculating your tax liability, depreciation's a good thing. So without cost seg you get a small piece of those depreciation deductions over the straight line over those years. 27 and a half or 39 years.
Brian LeFever:
What I want to show you is a strategy called cost segregation. I'll give you a little bit of the history of it. And the goal is to ultimately break this building, which is one asset, break it up into a bunch of pieces and then evaluate those pieces and see what we can depreciate faster, so we get depreciation deductions today or earlier than we would without it. I'm going to show you what that means as I get you through this.
Brian LeFever:
So that's what you buy. Here's what we're looking at for cost seg by breaking it up into these six main areas. Number one is site improvements. We simply say site improvements are everything outside the four walls of the building. This is the stuff on the lot. Here's some examples. I won't read this all to you and Terri says this is recorded so you guys can get access to this and actually slow me down. I can talk slower but I don't like to.
Brian LeFever:
So here's some examples of site improvements. Now these assets are considered, once we do this right, they're considered personal property not real property which means the law says they're not going to be worth anything in a shorter period of time than that 27 and a half or 39 years. Right? So the challenge with cost seg is again, abiding by the law. We have guides from the IRS on how to do this, so we have to determine what all those pieces are and what they're worth and here's the key, as a percentage of what you bought the whole project for. We'll get into that here in a second. So the goal is to identify the items and then figure out what they're worth as a percentage of the purchase price.
Brian LeFever:
Here's an exciting concept for engineers, probably not for you guys. Historically, and even with cost segregation, the building, the structure itself is considered real property, so that's the 39 year 27 and a half year stuff. The problem was historically, if you replace pieces of the structure and I always use the roof as an example. If you buy the property and replace the roof, you rip the old one off and put a new one on, the new one is now a new 39 year 27 and a half year asset. Right? So you have that on your depreciation schedule. Let's say you put 10,000 dollars on a new roof, you're going to get one 39th of that as a depreciation deduction for the next 39 years.
Brian LeFever:
The problem was there was no way to get the old roof out of your depreciation schedule and that was problematic because you're going to spend, let me use simpler numbers. Let's say you spent 27,500 dollars on a new roof on your rental property, right? So you're going to get one 27th and a half of that, so you're going to get a thousand dollars a year on deduction. You outlayed 27,500 but your tax burden today, it doesn't help you and you couldn't get the old one out. Everything changed though. 2014, they finalized what are called the tangible property regs and they introduced a concept called partial asset disposition. It's a phenomenal opportunity. We have to identify the value of the old roof again as a percentage of what you paid for the whole project and we get that this year as a deduction. So you might spend 27,000 dollars out of pocket, you only get a 1,000 dollar deduction on that, unlike other things like repairs and maintenance, you get it all the same year, but an asset you only get part of it this year and for future years.
Brian LeFever:
Now we can determine what was the value of the roof as a percentage of the purchase price and we get to dispose of that. So we get, I'll use a number, a 10,000 dollar additional deduction this year against our income further lowering our tax liability. So this is grossly misunderstood, partial disposition is one of the best things they came out with when it comes to real estate investment strategy because we were always stuck with depreciating two roofs even though we only have one roof.
Brian LeFever:
All right the next is personal property. The goal ultimately is to determine what of everything that you bought, we break it all up, what's real property and what's personal property. The personal property I'm talking about here is the easy stuff. We just call it stuff. It's the things that you buy as part of the purchase. We always use the example of a client ours bought a new manufacturing facility and it had an out building and in it it had a big lawnmower, a big riding lawnmower. That lawnmower has value as a piece of the property, of the purchase price. So in doing cost seg, we valued that lawnmower and if they didn't want it and they ultimately got rid of it, it could get it out of their depreciation schedule and take the deduction. So the stuff is a problem, because without cost seg, it's considered real property and we know it's not. So we have to go through and figure out, okay what's it worth as a percentage of what you paid for it and then as you dispose of it, you get the value of that as part of your tax strategy.
Brian LeFever:
So we'll talk more about personal property as I get into it. This is the easy stuff, the things that you know are not real property. But unless they're carved out in the purchase contract, it's called the purchase price allocation, you're stuck with calling it real property and that's what cost seg fixes.
Brian LeFever:
All right, let's talk about fixtures. We simply say fixtures are all the stuff on the floor, walls, and ceiling of the rooms inside the property. Here's some examples. Right? Some of this is considered real property just by the way the law works, some of it is personal property. It is considered to depreciate very fast. A lot of it is going to be 5 year assets, so we're going to get its full depreciation value in the first five years of owning the building instead of waiting 27 or 39 years. So cost seg again, we have to identify what you bought and then figure out what it's worth as it relates to the purchase price.
Brian LeFever:
Went too fast. All right, mechanical is not that important to those who own the residential stuff, more important to the industrial, commercial folks. Some of your plumbing system in a rental property or a residential rental property, we'll be able to re-class as personal property. Not all of it, so I don't waste a lot of time here, just know that it's there and you don't want to look at that, we don't want to overlook benefit and value when we're going through segregating our properties.
Brian LeFever:
All right electrical. This is the fun one. Lots of lawsuits, lots of court cases around how to handle electrical when it comes to accelerated depreciation. I simply say it this way. There's three types of electrical assets in your purchase. The first one is distribution, so this is what brings the power to the property. Right? The next is the wiring, getting the power from say the panel to the fixtures that are using the electricity. And in the picture is simply your lighting examples of outlets, anything that's using power. Right? So the law's evolved over the years to say we can add up the cost of all this and based on how the electricity is being used, we can depreciate faster components of the total cost of the EDS, the Electrical Distribution System. It's a little complicated, but this is why CPAs can't do this. They need an engineer to come in and do this analysis and that's what we built.
Brian LeFever:
So it's a fun part of the law because ultimately there's no way to figure this out without doing a full blown cost seg, but we get a big chunk of the electrical distribution that theoretically and it's intuitive to say, "Well, the electrical system is part of the building, so it should stay with the building" but the law over the years say, "Well, not all of it." And if we can accelerate the depreciation, I'll show you here in a second how that puts money in your pocket.
Brian LeFever:
So depending on how the electrical, the electricity is being used determines how we reclassify the EDS. Right so for cost seg, we have to add it all up, we determine how the power's being used, and we carve it all out. So, that's a very high level understanding or hopefully an introduction of the goal here. You have one asset on your effects schedule right now. Cost seg is the strategy of breaking that down into a bunch of pieces and looking at those pieces individually as assets. All right, hopefully this makes sense. Makes sense to me as an engineer.
Brian LeFever:
Misunderstood in community, you do not have to do cost seg the year that you bought or built the building. You can certainly, but you can also do it later, so I'm going to show you what that looks like. So I have a 500,000 dollar office building as an example here and I apologize I think most of you guys are on the residential side, but it all works the same. Without cost seg, that 500,000 would be depreciated over 39 years or 27 and a half. With cost seg, we're going to break out pieces and parts and we're going to reclassify them. In the re-class process, they're going to fall into shorter lives and the biggest buckets that we see in cost seg are going to be 5 year assets, 7 year assets, and 15 year assets.
Brian LeFever:
So this 500,000 dollar office building and again this is just an example. Every property is different and the numbers are all different. If you did it in the year that you bought it, the additional depreciation that you can realize by doing cost seg, the first year the year you bought it is an additional 24,000 dollars. That's 24,000 dollars in additional expenses and again not real money, it's paper loss, reduces your taxable income so you pay less taxes.
Brian LeFever:
The second year in this example is 38,000 in additional depreciation because we're pulling this 5-year, 7-year, 15-year property back for the next few years, we're going to have more deductions than we would have without it. And in year 2 which is really the third year you're claiming, here 22,000 as an example. Now let's say you guys have never heard of cost seg and you bought this property three years ago. You've been depreciating it straight line for the last three years and you want to to cost seg today. Same assets, same analysis, this year's benefit is 85,000 dollars in depreciation. The concept is called catch-up depreciation. The law says when you do cost seg, what you have to do is determine how much would you have depreciated had you done it the first year. And you depreciated it slowly over those three years, so what you missed, you get this year.
Brian LeFever:
We catch-up to where we would've been if we had done it from the beginning. As you can see this number, 85,000 is bigger than the 24,000. Same assets, same analysis, just you delayed in taking the benefit. It's amazing to me, we work with CPAs across the country, the common misconception is if you don't do cost seg the year that you buy it, you've missed your opportunity and it's not true. And I'll get into that a little bit here in a second. You have a little bit less in depreciation the next few years because you got more in the first year, which is where we want it. Right? We want to take as much deduction early as we can, we want to defer our tax liability sooner rather than later.
Brian LeFever:
Now, same property, you can see the numbers jump 105,000 in this example because we have now depreciated and caught up all the 5-year depreciation, all the 7-year depreciation, and two thirds of the 15-year depreciation. Ten years into it if it's a 27 and a half year asset, we're only roughly a third into the depreciation of this life, but these assets now are fully depreciated and we see that benefit in this year's tax return.
Brian LeFever:
All right, so we'll talk about deductions for those of you who aren't real kind of interested in tax. The way that... Oh, and I'll talk about that here in a second. We had a pretty cool video on titanecho.com that talks about how cost seg runs through the tax return. So let's talk about a concept called effective tax rate. The way we are taxed in the U.S. is a graduated system. So your first 15,000 dollars in income, you have one rate and the more you make, the higher the tier you go, the bigger percentage of tax you pay. So when you run your tax return with you CPA at the end of the year, an important number to look at is after all of your strategy what is your effective tax rate. In other words, how much did you make and how much did you give the government?
Brian LeFever:
I'll use the number of let's say 25%. Right, 25% it's not fabulous, but it's not horrible, so if we can come up with an additional 100,000 dollars in deduction and lower our tax liability an extra 100 grand that means we are saving 25,000 dollars in taxes. Okay? Now we're going to talk about that because if we get into the next years you can see it flips. It goes negative which means somewhere in the future here, we're going to have fewer deductions, so our taxable income is going to be higher because we took them early. That's not a bad thing because you'll pay more taxes later but you're going to pay it with deflated dollars because the dollar's going to be worth less in the future.
Brian LeFever:
So this concept, what you're looking at here, throws lot of people and if I'm throwing it at you too fast, and you want me to slow down, I'm happy to, but I got to believe that there's people in the audience that don't give a damn about this stuff. You just want the numbers. Right? So I don't want to go too deep and bore people.
Brian LeFever:
All right, here is what you got to come away with.
Trent Warner:
Can I ask you a question real quick?
Brian LeFever:
Absolutely.
Trent Warner:
So Chang wrote in and said, "Is rooftop HVAC, can that be considered part of those mechanical systems for cost seg?"
Brian LeFever:
Probably not. And I say probably because we're going to get into the body of law a little bit here and how this is done. If the HVAC unit is for general creature comforts in the property like keeping the place warm or cool for use to the building, it's technically considered 1250 property. It's going to stay 27 and a half or 39 years. We can get some HVAC units, the example I use a lot is in an office environment if you have a server room with a lot of server computers and they generate a lot of heat and you have an air conditioning unit dedicated to that room, that's considered business property because it's directly serving the business. So most HVAC is going to stay 27 and a half, 39 year. If we can make an argument that it's business property and here's an example.
Brian LeFever:
We did a cost seg project on a medical marijuana manufacturing plant in Connecticut and their HVAC system, they spent I want to say a quarter of a million dollars on the HVAC system for the grow rooms. We got to classify all of that as personal property. So you got to make the link to the business and that's really the underlying law. And I'm going to get into the law a little bit here, but hopefully I answered your question if it's generally residential or an office where your creature comforts for the folks that are using the office, we generally have to lead with the building.
Trent Warner:
Okay and one more before you get into the next pieces, when you sell the property, are you having to pay that depreciated tax back?
Brian LeFever:
Yes. It's called depreciation recapture. It's taxed at a different rate than capital gains, so if you buy a property for 400,000 and you sell it for 500,000, right? Capital gains, you're going to pay the capital gains rate for the 100,000. That's the profit you made just like if you buy a stock low and sell it high. If you buy it for 400,000 and you depreciate whether it's straight line or you accelerated the depreciation, what you are saying for tax purposes is the value of that 400,000 dollar purchase is getting less and less. If you ultimately then sell it for 500,000, you pay capital gains on the 100 grand between the purchase and the sale, you have to pay recapture tax because for tax purposes, we are depreciating the benefits. So you have to pay a tax back on that. So yeah, it's not a gift and that does lead me into what I tell a lot of investors, this is a long term play.
Brian LeFever:
Right? And that leads me to this slide here, the idea here is if you're a fix and flip guy, cost seg is not worth the time and the money. Okay, it's those of you that are buying and holding and you're going to use that advantage long term and this is what it looks like.
Brian LeFever:
So I love this graph. We actually built this into our software. Don't get hung up on the numbers, I want you to focus on the trending of the lines okay? So the red, we say the red is how much of the IRS's money you can hold on to interest free. So in my example of a 100,000 dollar additional deduction at a 25% effective tax rate, you're holding onto 25 grand in cash that otherwise you would've given the federal government.
Brian LeFever:
Ultimately, this red line always goes to zero because if you keep that property for 27 and a half years, you're going to get all the deductions whether you accelerate it or not. So eventually you're going to pay it back, you're going to pay the same amount of tax, which is kind of interesting because the tax reform act of 2018, when they lowered the effective tax rates across the board. Man, the investors that understood cost seg, everybody was cost seg-ing in 2017 to lower your tax liability in 17 because in 18 your tax rate's going to be lower, so that was a net savings because of the timing difference of the change in the tax rates but ultimately if the tax rates don't change, you're going to pay the same amount of tax. That's not why we do cost seg. This isn't a gift, this isn't free money, it's a loan.
Brian LeFever:
The yellow represents your return on that money you're holding onto interest free while you have the money. Now we always use a very conservative internal rate of return of 6%. If you're a decent real estate investor, you should be well above that. But that's what you're seeing here. This trendline is actually parabolic. It's compounding interest. So if you can hold onto their money interest free, pay it back over the remaining life of the building, you can take that 25 grand or 50 or a 100 or whatever it is, that money that you're saving in taxes, you can reinvest. You can put it into repairs on your property, you can put it into a down payment on another property.
Brian LeFever:
The whole concept here is accelerating your wealth using federal dollars that you're borrowing at no interest. That's the game in cost seg and this is why fix and flip guys, this doesn't help you because if you sell it here early the yellow, you didn't really get to use the money very long, you had to give it back when you sell, that's the recapture tax, so it's a long term play. Hopefully that makes sense and certainly shout out at me on the chat and interrupt me and I'm happy to slow down if you want me to. I just want to keep everybody's interest and keep moving.
Brian LeFever:
Okay. Here's how we do cost seg. You have to understand that our background, Titan Engineering, we have a very, very positive successful working relationship with the IRS. People think that's weird, the IRS has an engineering department, we know most of those guys, we're going to do it right, we understand the law, we respect the law. What we did was we coded complicated legal stuff into a software platform so that you guys don't have to learn the law, you just use the software.
Brian LeFever:
So if you follow the audit guidance, it's called the Audit Technique Guider, ATG, you'll hear me use that term. This is guides form the IRS to investors that are doing cost seg saying if you want to use these strategies this is what you need to do to be defensible on your tax return. So I'm going to sum it all up and not go too deep.
Brian LeFever:
To do cost seg, there are three pieces of getting the job done. The first piece is called Onsite Verification, that's their term or OSV. The laws says that we have to verify, we have to prove that those assets exist. We can't just make up numbers. So it's simply what we call the field work and we teach you, the investor or the realtor, those realtors on here, if you want to provide cost seg services for clients, we teach you how to use our software to go and capture the data from that property. The whole strategy around Titan Echo was we're sitting in Denver, I can put an engineer on the plane to go do the field work, but that's expensive. What we did instead is we codified a very simple, a bit tedious, but attention to detail, but a simple way for you guys to capture the data we need to move forward.
Brian LeFever:
So to do cost seg, first thing we're going to do is gather what we call supporting docs. These are documents that an IRS guy would ask for anyway, so we ask for them upfront. Things like your purchase contract, your closing statement, your tax assessor's doc, the appraisal. If you don't have them, we can live without them, but if you do have them we want to incorporate them. Then we're going to train you. We're going to connect you with one of my construction analysts, I got a team of engineers here in Denver and this is all they do. So you have remote support, whatever you need. We also have a knowledge base built into the software so you can be self taught. If you want you can teach yourself this at your own pace at night on the weekends.
Brian LeFever:
So we built an app, a desktop app, to do the heavy lifting and we also built a mobile app. The mobile app was designed to use a tablet like an iPad, take it to the field, you're going to get pictures and measurements. You don't need any experience in construction, we're going to guide you through what you need to capture. And keep in mind what we're trying to do here is to determine what's out there and we want to do it as fast as possible but we need to be accurate. So the mobile app, you can use a smartphone, an iPhone if you want. I don't like that because the screen is too small, I scroll around too much. I use a little iPad mini and it works real well. So you're going to go the field, we're going to teach you what you need to get pictures and measurements of. Even if you don't know what you're looking at, you're just going to quantify it, get a picture and we're going to help you through it.
Brian LeFever:
You're going to systematically capture all that data in the app and when you get back to the office or the house where you're on WiFi, you push a button that sucks all that data off the tablet up to the server where we can use it. The we take that data and we go into the second phase we call, or the IRS calls Construction Cost Estimating or CCE. This is what we do, we're very good at it. I've got a great team, they're very efficient, very accurate, very cost effective.
Brian LeFever:
We're going to take your data, we're going to review the supporting docs first right? So we'll extract whatever we need to out of those documents that are applicable and then we're going to ultimately do the takeoffs and the quantities based on the data you captured. The idea is that ultimately, if you have cost data, if you built the building and you hired a contractor, we have to use the contractor's cost data. Most of you, you're buying the property, you have no idea what it costs to build, so I got to come up with a construction cost estimate to rebuild it. So we use our database, think of us like a general contractor that bids to build a new building. We have our own cost database and I have to defend that in front of an auditor saying, "Oh, your number's good."
Brian LeFever:
So this is probably too deep of a dive that you guys want, so all I want you to do is take away from this slide is this concept called Reconstruction Cost New. It is foundational to successful cost segregation. So the way I explain that quickly is you could go out to your property and identify the stuff that you want to reclassify like the carpet. Carpet's going to be a 5-year asset and you can throw a number at the carpet and say this is what the carpet is worth. The IRS guys says, "Well, you got to prove that." The only way you can prove it is to bill up the costs of everything and compare the total cost which is Reconstruction Cost New, compare that to what you did pay for it because if you got the property at a deal, then we have to prorate all of those values down so they tie up to what you spent. So RCN is the key to defensibility. We're very good at it. That's our job.
Brian LeFever:
We have to prorate all of our costs so we built up a cost estimate as if we're going to go out and build the building, but then we have to prorate it all and I'll have to approve of all that. That's my job. That's the second piece. At the end of the Construction Cost Estimating work, we now have a building that you spent X number of dollars on, we carved out the land, what's left over is the depreciable stuff, straight line. We're going to break that up into somewhere between 100 or 200 pieces. We'll call it a 150 pieces.
Brian LeFever:
The third part of the puzzle is called Legal Analysis. And this is the challenging part, this is the part that you probably don't care about, but I'll give you some options. Ultimately, we have to look at all those 150 pieces under this body of law. The body of law is a little complicated. It is evolved from the 60s, we tell folks that there's about 200 court cases that could apply or could affect our analysis of what we do with those pieces. The goal of course is before cost seg, you have one asset, it's considered real property or what they call Section 1250 property, that's Internal Revenue Code Section 1250, that's the straight line stuff.
Brian LeFever:
The goal in cost seg is to break up the pieces, get costs associated to them appropriately, then figure out which ones we can reclassify as personal property, that's called Section 1245 property. So once we make that analysis, then the stuff that we can reclassify as personal property, we have to apply what's called the MACRS Asset Class system to it. This is the statute that says, "Is that a 5-year asset, a 7-year asset, a 15-year asset?" And again not very straight forward, but it's just the way they built it. Once we identify the items, those pieces and parts and what we can re-class, that's why we have dollars to that and what their new depreciation schedules are, then the software just recomputes how much depreciation should you have taken at this time if you had done it in the beginning. And that's your catch-up depreciation.
Brian LeFever:
Catch-up depreciation is actually if you guys care about tax law and statute, Internal Revenue Code Section 41A is where it lives. It's part of the body of law, the statute in America that says, "If you missed depreciation, you can catch it up the next year." It's done on a form, a complicated form called 3115, if we have an CPAs on the call by chance, CPAs hate this form, it's just messy. We do it for them. That's how we get this benefit of cost seg into your tax return. So that's the three pieces of the puzzle on how legal analysis, we generally do for our investor clients, our CPA partners that do a lot of cost seg, if they have the appetite, we have a training program to teach them how to do their own legal analysis. We offer that to investors, but most of you guys don't care, unless you really want to do it. It's a pretty steep learning curve. We can put you through it if you have the appetite, but it's only going to make sense if you have a lot of property and you want to get more control over the projects.
Brian LeFever:
So that's the three pieces of the puzzle on how we run the business. All right, this is my last slide. I did not start my clock, I hope I'm on time. So if you guys are interested in this, I'll give you my contact information here at the end. There's really two parts to it, it's pretty simple, we try to keep things simple. You can get access to the Echo platform, it's all cloud based. Titanecho.com is where you can go, you can actually get access tonight if you wanted, we do charge for that access, it's 25 bucks, it is month to month, you can cancel any time. I got investors that come in, they do one project and they're out in a month and then six months to a year later, they come and do another one. I got other partners that do a lot of cost seg and they just keep their access open.
Brian LeFever:
For that 25 bucks you get two things, number one you get what we call the Echo Matrix. The Matrix is our underlying benefit estimating module. We do have I'll call it a cheesy estimating option on our website, it's not very accurate. It's a legion tool, we don't ask for a lot of information, so it's not really specific. If you want to get a solid estimate to make a good decision, getting inside echo is a better way to go. So what we did is we built underneath, we built a predictor model on top of all of the cost seg data that we have. So we can predict pretty accurately what would a cost seg benefit look like for you based on your facts and circumstances. What type of property is it? How much did you pay for it? How long have you owned it? And all those factors roll into this Matrix estimate and you can get a benefit estimate before you decide whether to not it's worth doing. And it's necessary right? We want to be able to show you what it's worth so you can decide if it's worth doing.
Brian LeFever:
The other part of the 25 bucks is what we call the Learning Academy. We spent the last I would say 3 years pretty heavily in building out a knowledge base. In the beginning early on in our development of this, we spent a lot of time holding your hand and walking you through it, but that confused people because it was all verbal and there wasn't any real construct. So we built this knowledge base inside the software that's really designed to teach you a do it yourself model on how to number one, first and foremost, how to do the field work, how to run your benefit estimates, how to engage, how to run your field work, all that is built in there, videos and tutorials. So it's come quite a long way. We're always working on it but you can actually get access to Echo on a Friday and teach yourself how to do the field work and be done on Monday if you wanted to. So we're really spending a lot of time to give you those tools and that power to run your estimates and then ultimately execute the field work.
Brian LeFever:
That's step one if you want to get into this because it's really cost seg, I can't really help an investor evaluate the benefit of cost seg without actually getting into the trenches because your situation is unique. So that's simply the first step, you can get to it from our website if you want.
Brian LeFever:
Second step is determining your ROI, your return on investment. Cash is king, you guys have all heard that and you can spend your money on a lot of different things, improvements to your property or better marketing or whatever, those dollars you have to figure out the best return on those dollars that you have in your hand. Cost seg is a strategy that may or may not be the best use of those dollars right? So we want to give you the tools to make that determination.
Brian LeFever:
I want to slow down a little bit on this concept called Utilization. Because depending on your situation as an investor, utilization may be a problem for you. And I did mention earlier on our homepage, titanecho.com, there is a button to watch a video about how the cost seg benefit runs through the tax return. We do a little bit of a deeper dive into utilization. What I would tell you is if you have a CPA, you can run your benefit, your Matrix estimate and give them the numbers and they will run it through your tax return to tell you can you use all those deductions or is there something in your tax return that's holding you up. If it holds you up, you'll use what you're allowed to and then the rest gets carried forward, right? That's not as valuable right? If we're talking about an interest free loan from the government, you want to reduce your tax liability now. If you can't use it all, just because you can segregate your property doesn't necessarily mean it's going to lower your tax bill.
Brian LeFever:
Now I can't see your tax return and even if I could a lot of that stuff is a little beyond me. I got to got to a CPA myself. If you're doing your own taxes, you open up TurboTax and you plug in an additional depreciation deduction on schedule E, it will run through for you. So either way, we strongly recommend once you get your benefit and know what it's worth, run it through your tax situation whether your CPA does it for you or you do it yourself before you decide to move forward because you don't want to spend money on a strategy that ultimately isn't saving you money. Shoutout to utilization, I always want to slow down for that because I can't predict whether or not that's going to be a challenge for you.
Brian LeFever:
All right, here's Echo's cost. I'm going to go kind of high level, I don't want to really dwell on this but people are always asking what does this look like, what does it take? Number 1, you run your Matrix estimate, you like the number, you verify utilization, yeah this is going to save you money this year, you pull the trigger in the software, you hit a button and you're signing the engagement letter for that project. We charge you 500 bucks for the access to the platform for that project, then depending on the size of the project, we have a pricing strata around what we can do for you. So here's the first three, they go higher than this. If the property is under a million dollars in basis, that's the first strata, 1 to 2 million, 2 to 5, they go up from there. The biggest project we ever did, I put this out all the time, 180 million dollar project we did, it was actually the Macy's department store in the Embarcadero in Downtown San Francisco.
Brian LeFever:
I am looking for 200 million dollar projects, so if anybody here on the call has a 200 million dollar project, I want to talk to you. Okay, so we can do all sizes. I'm just giving you the first three, I don't know who the audience and how big your stuff is and then obviously we generally do the construction costs estimating and the legal analysis. If you know how to run a construction cost estimate and you want to learn the legal analysis, you can do the whole thing yourself.
Brian LeFever:
On our software it's going to be faster, so it would only be 500 bucks but most people you can't do the construction cost estimating better or faster or cheaper than we can. So under a million, we charge a 1,000 dollars, legal analysis 600, so that plus the 500, you're into us for 2100 bucks to do a cost seg. Now you can hire a cost seg consultant, there's guys out there running around the country doing cost seg. I can assure you they're not as good as us because we're kind of tied in with the IRS, but they're going to be more expensive because they got to get on a plane and they got to do the field work. If you do the field work, you'd save a chunk of money. 1 to 2 million, I won't waste a lot of time on this. They go up from there because obviously there's more work to do, 2,000 for the engineering, 1,000 for the legal. Next one up is 3,000, 1,500, and they keep going up.
Brian LeFever:
Uh-oh. I'm running out of battery. I will go faster. If by chance I get kicked off, I will get back on, but I am about done. I want you to come away with the idea that the cost of doing cost seg is like a loan origination fee for a zero percent interest loan. There's not cheaper money in town. I said that very frequently in the past, today we all know the interest rates are extremely low, but borrowing the money interest free, you pay a little bit to put it together upfront, so that it's done right, but the beauty is there is no bank qualification here. This is all federally mandated strategy and you don't have to qualify for this, you just have to do it right.
Brian LeFever:
And that's the end of my presentation. I know we have Q and A. This is my contact info you guys can have this, I'm going to go off the screen to get my power strip because I thought I had enough power on my laptop, but I don't. I am here, I can still talk to you. I'm just going to run right over here and grab my power strip, I apologize. I'm still here if you want to ask questions.
Trent Warner:
Brian, thank you for sharing all of that information. I know I have a couple of questions and I'm sure Jacob does as well. And I'll be monitoring the chat and the Q&A if anyone else has questions, feel free to type them down in the boxes below. I know Brian said that he was going to be right back, but I'll wait until he gets back.
Brian LeFever:
[crosstalk 00:38:47]. I'm almost there.
Trent Warner:
Okay. All right. Jacob, do you want to ask a question to start us off or I have one written down here if you're not ready?
Jacob Wathen:
Go for it.
Trent Warner:
Okay, it's kind of earlier on in the presentation, so for the catch-up cost segregation, is there a time period where you would recommend, I know a lot of people won't do it in the first year, but say is it year 5, year 6, year 3, is there some kind of sweet spot year that you see a lot?
Brian LeFever:
The biggest catch-up depreciation year because of the way depreciation works is going to be year 2.
Trent Warner:
Okay.
Brian LeFever:
And then year 3 is going to be better than year 2, but not as big of a jump as it was from year 1 to year 2 okay? So at some point, cost seg is not worth doing because if you own the property for 20 years, you've already depreciated 20 years of a 27 and a half year life, you're going to get some benefit, but it's probably not going to be worth it. So I generally tell folks, somewhere in the 7th to 10 year mark, the benefits start deteriorating to the point that the ROI is just not going to be there for you.
Trent Warner:
Okay.
Brian LeFever:
I would still say run a Matrix estimate because I can't guess, I can't predict, I try and I look like an idiot. So it doesn't hurt to run the estimate and make your own decision on ROI, but somewhere around the 7th year is where we don't do cost segs on 15 year ownership properties just because the investor looks at the number and says it's just not worth it. I'm already halfway through my depreciation on this one.
Trent Warner:
Right, okay. Cool
Jacob Wathen:
Makes sense. Yeah, I do actually have a question. So my property is kind of weird, it's one unit is residential and one is commercial, would you usually just lump it together since it's all on the same lot or what would be the best way to do the cost segregation for that?
Brian LeFever:
It depends Jacob. Did you buy them together at the same time?
Jacob Wathen:
Yeah.
Brian LeFever:
You have one closing statement?
Jacob Wathen:
Yup.
Brian LeFever:
Okay, that helps. Are the lots, are they both on one lot meaning that you have one tax bill?
Jacob Wathen:
Yes.
Brian LeFever:
So that's one project for us because I can't separate the land improvements we were talking about. There's no way to break them up building by building, so we'd treat it as one big property. Do you know how you're depreciating that because there's rules around that mixed use stuff?
Jacob Wathen:
Not 100 percent sure yet. It's only about two months and we still need to figure that part out, that's why I was excited.
Brian LeFever:
It's going to come down to percent of square foot that is residential versus commercial and I can guess the number, but I would usually leave that for the CPA. They're going to tell you you're either going to depreciate the whole thing as either 39 year or 27 and a half year based on that analysis. We don't provide tax advice, we're just the engineer, so we defer to the CPA on how they want to depreciate it higher to cost seg. And then the component with the stuff that we break out, the 5, 7, 15 year stuff, we're going to get out of that whether it's 39 year or 27 and a half year. You still have a benefit, but yeah it'd be all one project in that case.
Jacob Wathen:
Sounds good.
Trent Warner:
I haven't seen any other questions come in, so I'll ask my other one. Where'd it go? I guess you kind of just touched on it, mixed use. Have you ever had to defend a study with the IRS?
Brian LeFever:
Oh plenty.
Trent Warner:
How does that usually go?
Brian LeFever:
The beauty... Our reputation centers around we've never lost. We have to put in our engagement letters that we are required in writing to say we can't provide any guarantees in front of the IRS, but if you understand the rules and you follow the rules, the law is in our favor. What we have done over the last ten, eleven years we actually get called into exams that are not done right and we hope the taxpayer rights the ship and defend their position. And a big chunk of my responsibility as head of ops here is I get to sit across the table from IRS engineers all across the country.
Trent Warner:
Very nice. I know you said you did a 180 million dollar project, do all projects take the same amount of time?
Brian LeFever:
No. If you're a cost seg... Let's say you have a super family house and let's see Portland, what are we at what? 350,000 in depreciable basis with the land carved out whatever you paid for, we'll call it 350,000. And you want to do full blown cost seg as opposed to Echo Lite and Echo Lite is where most of our investors in that scenario are going to go because the ROI is much better, but if you want to do full blown cost seg and you're going to do the field work, you're going to be out in the field getting pictures and measurements, it's going to take you a few hours.
Trent Warner:
Yup.
Brian LeFever:
The engineering, we say if we do the engineering and legal, either way when you hand it off to us and we turn it around, our standard position is we can turn projects in somewhere in between 7 and 30 days, but it all comes down to the time of the year. We're in tax season right now. 9/15 is coming on us, so we're jamming busy, so our turnaround time stretches out because they're coming in faster than you can do them.
Trent Warner:
Right.
Brian LeFever:
You do a project in May, my guys are playing Nerf basketball in the bull pen because they got nothing to do.
Trent Warner:
And then I'm assuming that commercial and residential, different timelines for that as well?
Brian LeFever:
If you're talking about timeline as far as global effort for field work, it's going to come down to the size of the building okay? Because you have to capture more data. The engineering and the legal, well the engineering analysis, we have different factors, if we had construction drawings that we have to use, they slow us down. Depending in your case, Jacob if you have two buildings, obviously that takes a little more work than one building for us on the engineering side. So we have metrics, usually when you hand yours stuff off to us, someone on the team takes a look, makes sure it looks complete and we can estimate when you're going to get it back from us.
Trent Warner:
Okay. Oh I guess a follow up question for the defending a study against the IRS, is there an additional fee for that? And if I'm audited and they question the study is there a fee for you to come and defend the work?
Brian LeFever:
Looking through our engagement letter, we do audit support at no additional cost. Back that up, we do remote audit support at no additional cost. If we have to get on a plane, we have to charge for the travel costs but I've been seeing the IRS especially in cost seg, I haven't seen them traveling. They just don't need to. It's a cost to them.
Brian LeFever:
If they did want to come and look at the property, which is a little odd these days and if you wanted us to be there to represent you, obviously there's a cost there, but generally all our work today is done remotely, phone and video conference with the IRS guys. If we lay it outright and they actually taught us what they want to see right? Over years of doing this and that's why we do audit work for free because we want to be in front of the IRS. People think that's weird, but when we got started we didn't have any experience in tax. We're just engineers and coders, what we want to do is understand what it is that they wanted to see and what makes their job easier and then back into how do we get there as efficiently for you as possible.
Trent Warner:
Mm-hmm (affirmative). Okay.
Brian LeFever:
Yeah, if you did a cost seg with us and you got a letter saying, "Hey, we want to look at your depreciation." You want to call us, we'll get on the phone with the auditor and your CPA or you, however you want to do that and we actually run the exam. That's fundamentally in the time that we do and a lot of that's on me in my position, we have other guys as well, but I build that time to what we call product development. We're constantly coding, we want those opportunities to be tested.
Trent Warner:
Awesome. And then I had one other one. Would you recommend to all real estate investors to look into this or to perform a cost segregation?
Brian LeFever:
I love that question because the answer is if you're an investor that has no need for additional cash then don't look at this. But if you can take cash and make money with that cash, yeah, you should be looking at this because you can leverage this strategy to grow your portfolio faster.
Trent Warner:
I love that answer to that question.
Jacob Wathen:
Me too.
Trent Warner:
It's all about the momentum of your working capital. How can you deploy that to work more for you?
Brian LeFever:
Yup. I was talking to an old investor, he probably has I don't know 400, 500 properties scattered around mostly South Central Southeast U.S. and when I said that to him he was like, "I'm never not going to know what to do with extra cash. I'm always going to have something I can do with it."
Trent Warner:
Exactly. Right, so why not get it?
Brian LeFever:
That's right. We've got a couple of real estate brokers on, my wife's a real estate broker here in Denver so we have our own portfolio, we started in Southern California where we got married and so that's her full time gig and our portfolio grows. We cost seg everything.
Trent Warner:
And when you say everything, is that a hundred units or is that five units?
Brian LeFever:
We don't have real big properties, we do a lot smaller stuff in both commercial and residential. If it qualifies for Echo Lite, I will always do Echo Lite. I think that the cost benefit is there. There is a little additional risk in front of the IRS, but we built it right, it just needs a little more analysis. I've never failed to defend an Echo Lite calc. I would not do full blown cost seg if it met the criteria for Echo Lite. I think you're spending money, you don't need to. Some folks say, "Well, I want to follow the rules, I'm willing to pay extra because I'd feel more comfortable." That's totally fine.
Trent Warner:
It kind of sounds like though it's worth it to someone that may have one unit, two units, or 400 units right?
Brian LeFever:
Absolutely. I'll always go back to that utilization. The big stickler for folks if you're new in the investment game and you're not, the legal term is called Designated Real Estate Professional, it's something that your CPA has to get behind if they're doing your tax return or you got to read the rules yourself and make sure you can defend that. If you can't get behind that designation, then you use accelerated deductions are considered passive losses and they can only offset your passive income. It can't offset your W2. If you can beat that and the realtors on the call here, you most likely can, but I can't provide tax advice. My wife does, my CPA every year quizzes her to make sure we're within the rules. So when we buy property, we segregate and we bring a massive amount of depreciation deductions forward. Not only does it wipe out her taxable income with her business, but it takes out a chunk of my W2 withholding that they're taking out of my paycheck.
Trent Warner:
Yeah.
Brian LeFever:
And we get a nice refund every year. Now we are kicking the can down the road and sometime down the road, I'm going to have more tax to pay, but so what? My portfolio is bigger. The rent will be paid.
Trent Warner:
Can you, I don't know if you know the answer to this, but can you defer the depreciation recapture if we 1031?
Brian LeFever:
It's a bit complicated. The tax reform act of 2018 put some wrinkles in that I'm not, I haven't seen enough of that to give you any kind of answer to confidence. I would tell you it's harder now than it was prior to one of 18. And it has to do with the heart of the tax reform act was say they're trying to put the screws to doing a light kind of exchange on personal property and that's problematic.
Trent Warner:
Yeah.
Brian LeFever:
Before that, it was a great strategy to do cost seg right before you flip it in a 1031 because you get that massive deduction and then you buy something bigger and your basis is real low.
Trent Warner:
Yeah.
Brian LeFever:
So I would tell you that I got a lot of QIs I work with and the fact that I did this presentation last month with a group of qualified intermediaries that all they do is 1031 and they're trying to figure out how this cost seg play into their strategy for their clients under the new laws.
Trent Warner:
Interesting. Yeah, I'll have to talk with my CPA about that and see if I could quiz them on that.
Brian LeFever:
Yeah. Definitely and if you guys are doing 1031 and you have a QI that you know, I would quiz them as well because they're paid to understand the 1031 rules.
Trent Warner:
Cool. I think that's all we have in terms of questions at least in the Q&A and the chat mods, so thank you again for your presentation. Like I said, this is the main event. I've learned some stuff. I hope everyone else did, so I appreciate you taking the time to talk with everyone here tonight.
