Profitable Painter Podcast
Profitable Painter Podcast is a rich resource for anyone interested in starting, running, and scaling a professional painting business, offering valuable insights, strategies, and interviews with industry leaders. Through case studies and in-depth discussions, we deliver a vivid picture of the painting industry, with a disclaimer that any financial or tax information is general and not a substitute for professional advice.
Profitable Painter Podcast
Maximize Your Tax Savings: Cost Segregation Strategies for Real Estate Investors
Unlock the secrets of boosting your tax savings as a real estate investor with this insightful episode. Daniel, the founder of Bookkeeping for Painters, and Richard, the advising director, take you on a comprehensive journey through the world of cost segregation. Discover how this powerful strategy can accelerate depreciation and create valuable tax deductions, but be wary of the passive loss limitations that may restrict these benefits. By understanding how to qualify as a real estate professional, you might just find the key to maximizing your tax savings as the year-end draws near.
We emphasize the critical importance of consulting with an accountant before making any financial decisions, especially those influenced by alluring TV offers. Personalized advice is crucial, and we encourage listeners to share their experiences and seek guidance in the "Grow Your Painting Business" Facebook group. Whether you're a seasoned investor or just curious about cost segregation, join our community for engaging discussions and share your thoughts on future podcast topics. Together, let's ensure your tax strategies are effective and tailored to your unique financial situation.
This is Daniel, the founder of Bookkeeping for Painters.
Speaker 2:And this is Richard, the advising director of Bookkeeping for Painters. How's it going? It's going pretty good. You know we're in the well, we're towards the tail end of fall, kind of right before Thanksgiving. It's a great time of year because, you know, the weather cools off, the leaves fall and there's football year, because you know the weather cools off, the leaves fall and there's football. I know not everyone's a football fan, but I do enjoy watching the game. Got a route for my miami dolphins.
Speaker 1:Uh, kind of kind of keeps me um, connected to my home state of florida yeah, I haven't watched football in like 10 years but, uh, I did watch some sports recently. I watched the jake paul and mike tyson fight. Yeah, yeah, just just the fight itself, not the actual, all the undercards and everything that was, uh, it's pretty depressing. But, um, yeah, I haven't. I haven't been watching any football, but but I know, um, you were excited to tell me about a, uh, a football commercial and in regards to taxes, which was I thought was a pretty funny that they're advertising tax strategies on, on, uh, monday night football or whatever.
Speaker 2:Yeah, it was Monday night football. Uh, I've seen it a few times, and, as an accountant, you sit down to watch football and you see somebody pitching a tax strategy that they don't really know what they're talking about. It was a little shocking. What they were alluding to in this commercial and maybe you've seen it is what's called a cost segregation study and a depreciation strategy, and I'm sure if you called their phone number, they could charge you thousands of dollars to tell you what we're going to tell you for free right now on the podcast. So hopefully no one's called that number yet until you've listened to this episode, yet until you've listened to this episode. But yeah, people are especially interested in this because it's the end of the year and they're looking for last minute tax deductions. They've maybe sat down with their accountant and they know that they've made a lot of money and they're going to owe a lot of tax. So what can we do about it?
Speaker 2:In the right circumstances, a cost segregation, depreciation strategy can be insanely valuable. We just got done doing one with one of our clients, and he is going to save $33,000 on his taxes because of it. The trick here, though, is that you really have to have the right circumstances and the right situation in order to benefit from it. So everyone on TV and social media is going to tell you to go out and spend this money on a cost segregation study, but can you actually use it? So that's what I kind of like to talk about today. So how does a cost segregation work? Well, if you have real estate, you're probably used to taking a tax deduction for that real estate through depreciation, and it's either going to be over a period of 27 and a half years if it's residential, or maybe 39 years if it's commercial.
Speaker 1:And that's a long time, right?
Speaker 2:You take the purchase price of your rental house, you subtract out land because land never gets depreciated and then you divide it by 27 and a half years and that is the tax deduction that you get. What a cost segregation does is it is an engineering study that looks at your property and it breaks it up into its individual components. So now, instead of just looking at one property, you are looking at the roof, the mechanicals, the flooring, the window coverings, the appliances, the landscaping, the hardscaping, on and on and on, and you have all these different segments. So cost segregation segregates out the different costs and these things can be depreciated more quickly. So, for example, your appliances would get depreciated over five years instead of 27 and a half. Your landscaping might get depreciated over 15 years instead of 39 if it's a commercial building, and this allows you to increase your deductions, right? So instead of stretching it out over a long period of time, you are accelerating those expenses and depreciation up front, and this is going to create well, it's going to create deductions for you. So it's going to reduce the income that you get off this rental property and it will probably produce a loss on this rental property. And so that's where the tax savings come in.
Speaker 2:Generally don't tell you is that, even though you are creating all these losses in your real estate, you cannot use these losses to offset your business income unless you meet very specific criteria. So what that means is, if you have $100,000 of losses on your rental real estate because of your cost segregation and you have $200,000 of business income, you're going to pay taxes on $200,000 of business income and all those losses are going to stay with the real estate. They're going to be locked on what they call the passive side. These are the passive loss limitations and you're not going to get to use them until you have other passive income from other real estate or future years to offset. And that's really disappointing for a lot of folks who think that they're going to get a big tax break on their business income by generating these losses. So the trick is you have to tear down that wall. Or you have to tear down that wall or you have to get through that wall. I sound like you know Ronald Reagan from the 80s. Yeah, I'm dating myself, but that's the catch, right. So how do you get through the wall? Okay, here's the million dollar secret that they're going to charge you for if you call the phone number.
Speaker 2:You have to meet certain criteria. That's laid out in the Internal Revenue Code. So one is going to be you can qualify as a real estate professional. So think of a real estate broker or a house flipper or a contractor, someone whose day job, bread and butter, is buying and selling real estate. Now you have to qualify. You can't just say I'm a real estate professional. There's tests that you have to pass and I'm going to be honest with you, they're hard tests. It is not easy to qualify as a real estate professional under the IRC. If you have a W-2 day job or you are a business owner, it will be incredibly difficult, if not impossible, to also qualify as a real estate professional because there's simply not enough hours in the day for you to spend in your day job and buying and selling real estate to meet that test. I'm not saying it's impossible, but it will be a challenge. So before you mark that box that yes, I do qualify, make sure that you meet those tests. It's around 750 hours a year and there's some other aspects to it as well.
Speaker 2:Another way through that passive wall is that we typically call this the short-term rental loophole, and yes, I do use the word loophole.
Speaker 2:I don't use that word lightly, because it takes advantage of some kind of archaic language in the Internal Revenue Code. It is legal, but it is stuff that needs to kind of be updated for the 21st century, and until it is, there is a loophole there, and this would involve having a legitimate short-term rental, something that you are renting on average for seven days or less, so think like Airbnb, vrbo, that sort of thing. There are other tests, too you can't provide substantial services, and you also have to have material participation, and that's a tricky one. So we're talking at least 100 hours a year that you are participating in the management and the upkeep of this property, and you are participating more so than any other person. So this involves keeping time logs, this involves being very active in your property, and we are being pedantic here because this is a tax strategy that is taken advantage of a lot and this is something that will kind of raise some red flags. So if you qualify, you should do it.
Speaker 1:But make sure that you can dot your I's, cross your T's, keep all your receipts, because you are increasing your chances of an examination when you do this. And I I think this is the strategy that a lot of the folks that we work with that have have successfully used their losses on the real estate side to offset their their income on the business side. This is usually what they're doing is the short-term rental, having like an Airbnb, making sure you're actively participating over the 100 hours per year and documenting that, and then, if you're doing that, those losses on the Airbnb if you maybe did a cost segregation study or whatever way you're getting losses, those can offset your painting business income right.
Speaker 2:Yes, Yep, the short-term rental loophole tends to be the one where people go first because, like we mentioned, if you are running a painting business, you almost certainly do not have the time to also put in 750 hours a year as a real estate professional. One kind of way around that is that if you are married and filing a joint return, one spouse can qualify as a real estate professional, and then that would benefit both spouses. So you may be running your painting business and your spouse may be a realtor and they may qualify as a real estate professional. Now you've got that way through the wall. Now you can start talking about cost seg, depreciation and that sort of thing. So maybe we could run some examples to kind of help understand whether a cost segregation would make sense or not. You know, you imagine you know a business owner who owns a painting business. Maybe he's not on the brush anymore, he manages it, but he's still contributing. You know a good 30 to 40 hours a week on that business and he has, you know, some rental real estate he's renting out long-term to some folks. It's residential. Should he look into getting a cost seg? Well, it's probably not going to be worth his money because he does not have a way through that wall because he's not a real estate professional and he does not have the short-term rental loophole to fall back on, have the short-term rental loophole to fall back on. So in this case a cost seg would probably be a waste, unless maybe he's got a lot of rental real estate and a lot of passive income, because real estate or rental real estate is passive, Then we might have something to talk about. But for most folks who own only maybe one or two properties, it's not going to be worth it.
Speaker 2:How about another example? Here's a painting business owner who has definitely taken himself out of the day-to-day of his business. He's able to devote maybe 10 to 15 hours a week because his business is firing on all cylinders and he's got his key people in place and he just kind of is able to sit back in a CEO role. He buys a rental property close to him because he lives in an area that is frequented by tourists it's kind of a popular vacation destination and he spends his time cleaning the property, doing maintenance on the property, booking appointments, collecting rent, that sort of thing, and he flips that place to renters at least every seven days. Nobody stays there longer than a week.
Speaker 2:Well, now you have a short-term rental and you have an owner who has material participation because he's doing more work on the property than anybody else. That's a situation where a cost seg really could come in handy, because he's got a bunch of situation where a cost seg really could come in handy because he's got a bunch of non-passive business income from his pending business and he's got a way to take those passive losses, get through that wall and offset those, those business um, that business income. Uh, so you know before you, before you go and you buy a cost seg, definitely talk to your accountant. Uh, try to make sure that you understand what the goals are here, what you're trying to accomplish and whether you can qualify to do it. Uh, I know I mentioned this earlier, but I do want to emphasize if you are going to do this strategy, it's a wonderful strategy, but it is one that is abused frequently and it is one that the IRS is definitely got an eye out for.
Speaker 2:So make sure that if you're going to claim material participation, you have an hour log so that you can prove that you spent more time than anybody else on that short-term rental. Make sure that, if you're going to try and qualify as a real estate professional, you can show at least 750 hours a year. And, just as a side note, this is active participation. This is material participation. So, listening to podcasts about real estate, reading books about tax strategies, browsing through properties on Zillow, those are investor hours. They do not count towards your real estate professional status or your material participation hours. So we're talking about hours where you are actively on the property. So, yeah, I mean there's.
Speaker 2:We could go on for hours about this, but just the big takeaway is make sure that you are going to be able to accomplish your goal before you spend your money on a classic, because these things are expensive. They can be anywhere from. You know, I've seen them on the low end for about $750, all the way up to several thousand dollars, depending on how detailed they are. And before you give your money to, you know, a phone number on a TV commercial, you know, make sure that this is something that you can really benefit. Actually, don't give your money to a phone number on a TV commercial. You know, make sure that this is something that you can really benefit. Actually, don't give your money to a phone number on a TV commercial. Talk to your accountant, because they're going to give you good advice. They're not going to push you into something that you can't benefit from.
Speaker 1:Awesome. Well, if you have any questions about cost seg, does it make sense for your situation? Or maybe you've done a cost seg and like to share your experience with it? Go to Facebook, type in grow your painting business and join the group. Love to hear your thoughts or any thoughts for future episodes. And with that, we'll see you next week.
