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Simply Multifamily: Cost Segregation - The Hidden Gem of the Tax Code


Hear from Joel Dobrin of Cost Segregation Initiatives, LLC as he discusses Cost Segregation: The Hidden Gem of the Tax Code. Joel explains what cost segregation is, how it works, and how to implement it to reduce your taxes by accelerating depreciation and offsetting your current income. If you own commercial or multifamily property, this episode is a must for you!



Kiran Dhillon, SIG Commercial:

Hi everyone, welcome to our series called Simply Multifamily. My name is Kiran Dhillon and I am a Broker-Associate at KW Commercial, specializing in multifamily sales. I work with buyers and sellers of apartment and multifamily properties all throughout the greater Los Angeles and Inland Empire areas.


The purpose of this series is to highlight issues and introduce strategies that affect and benefit owners of multifamily properties via market updates, investment insights, and interviews with trusted professionals. Today we're going to be speaking with Joel Dobrin, Director of Business Development and Project Management at Cost Segregation Initiatives, LLC. Welcome Joel, it's great to have you.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Kiran, the pleasure and honor is mine. I'm happy to join you here. Thanks for having me.


Kiran Dhillon, SIG Commercial:

Of course. Tell us a little bit about your background and how you got into your line of work.


Joel Dobrin, Cost Segregation Initiatives, LLC:

So briefly a little bit of my background: I'm originally from the great state of New Jersey. I was a basketball player, came out and played college basketball at UCSB. When I first got out of school I got involved in the physical therapy equipment finance business, and I still have a little bit of dabbling in that. Hit fast forward 30 plus years, and about 15 years ago, it was just very serendipitous that I got introduced to a CPA and a construction expert through another contact who specialized in this area of cost segregation. And the gentleman that introduced me said, "Joel, you're working with medical professionals, some of them have to own their buildings. You should look into this." And I did just that, and it has become just a fabulous business to be part of, just really interesting, and as we'll talk about, the benefits are fabulous. I'm a married for 30 years to my wonderful wife, Lori, and got two beautiful daughters, Jenna 27 and Rachel 25.


Kiran Dhillon, SIG Commercial:

That's great. So, tell us about cost segregation. What exactly is it and how does it work?


Joel Dobrin, Cost Segregation Initiatives, LLC:

So, I still refer to cost segregation really as a hidden gem of the tax code. And I spend as just a large part of my time really sharing this information, I'm looking to educate people about how truly beneficial it can be. It allows owners of both commercial and in your focus, residential rental and multifamily apartment type of properties to accelerate depreciation, and by accelerating depreciation, it allows the owner to offset their current income and reduce their current income tax. And the way that we do that for a multifamily property is standard depreciation is set up over 27 and a half years. What cost segregation allows us to do is to go in and study that building and reclassify much of that property into shorter life periods of 5 years and 15 years. And at a very high level, the 5-year property consists of primarily interior elements, which in an apartment building would be things like carpeting, cabinetry, wood flooring potentially, some of the fixtures, some of the electrical, the security systems, IT, possibly window treatments, the exterior.


The 15-year property [contains elements that may qualify for 15-year depreciable life, examples of this could be]: landscaping, irrigation, sidewalks, curbing, fences, gate enclosures for garbage areas, those make up the 15-year elements. So if you just think about it conceptually, owners have an opportunity rather than to wait and get small bits of benefit over 27 and a half years, we condense that and we take the building and we move it into 5-year components and 15-year components. And they're able to receive that benefit much faster. And as we move further along, we'll speak about how it's even been further enhanced, but that's the teaser for a little later as we move down the path here.


Kiran Dhillon, SIG Commercial:

Got it. So what type of properties does cost segregation work best with, and are there any types of properties that there wouldn't really be a benefit to exploring cost segregation for?


Joel Dobrin, Cost Segregation Initiatives, LLC:

So one of the things that really attracted me and I found fascinating about this early on, is that the market is huge because [cost segregation is] applicable to all types of property, all types of commercial property and also all types of residential rental [property]. And whether that be apartment buildings, whether that be duplexes, triplexes, fourplexes, we've even done single family homes that people have bought for investment purposes. The key being is that it is not their primary residence. If it is not their primary residence, it's worth exploring to see what the benefits might be.


Anybody that is making money and paying tax might want to take a look at this. We have yet to meet anyone, in 15 years, that wants to overpay their taxes. That winning streak is still intact. So areas where it would not make sense is if somebody is not making money and is not paying tax, number one, or if they have a property with a building basis that is less than $700,000, because when someone purchases a property, of course, I'm stating the obvious here, they have both land and building, and cost segregation is solely focused on the building portion because the land is not depreciable. So we want to make sure that there's enough building structure there for it to make sense to explore.


Kiran Dhillon, SIG Commercial:

Got it. And maybe this touches on what you just mentioned, but do these properties need to be within a certain price range to benefit from cost segregation?


Joel Dobrin, Cost Segregation Initiatives, LLC:

I'll answer that, two parts to it. Number one would be yes, if there's not at least I would say $700,000 of building basis, then we wouldn't suggest it would be done. We just don't believe that there's enough benefit to be generated where it pencils. Now I will say there may be some folks in our industry that may say, "Oh, they would do it, and it makes sense," but we focus on quality and standards. And I think one of the other things that sets us apart is my partners are two of less than 45 individuals nationwide that are certified by the American Society of Cost Segregation Professionals. We are not interested in just collecting fees, we only want to pursue properties where we truly believe it makes sense, and we think that's a good benchmark and a good threshold.


The other thing, too, is people think that this is just applicable for new purchases and it surely is there, but one of the things that is not as widely recognized, is the fact that we can take a look at previously purchased properties. And our general suggestion is anybody that's owned a property for seven years or less, it's worth exploring cost segregation on because the rules will allow us to go back to the original date of purchase and put in place cost segregation, and then in a one-time catch up the owner is able to take advantage of those benefits. It's called a "Look Back Study" and it also serves to be very beneficial.


Kiran Dhillon, SIG Commercial:

And so that leads into my next question, which is on this end we can still utilize cost segregation, even if you've owned the property up to seven years. What about on the front end? Is it a good idea when buyers are looking to purchase a property to start thinking about cost segregation even before they're in escrow? Or is it something you want to look at after you actually have purchased the property?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Kiran, it's a great question. And I think for savvy owners, savvy business people that look at the totality of what does this acquisition mean, it's not only just the purchase, it's what is available to them once they close. And so if you have clients, or your folks have people within your sphere, so to speak, that are looking at a property, and if they want to get an idea of, well, if I purchase that property, what would cost segregation do? How would that play a role? Then what we can do is we can put together a snapshot that would illustrate what their benefits would be. And I think maybe just a simple way of saying it would be that for people that close on a property and cost segregate it shortly thereafter, it's almost like you get a cash rebate from Uncle Sam. Does that make sense?


Kiran Dhillon, SIG Commercial:

Yep. I do like this idea of when you're looking at a property, reach out to Joel and have [him] do an evaluation, because that can certainly factor into whether this is going to be a good purchase for you or not down the road.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Exactly right. I think maybe again, because it's an important piece to the puzzle, oftentimes people are looking at the front end of their purchase, the purchase price, the value, the loan situation, if they're getting a loan, but I think if you think about them integrating cost segregation, well, now once it's done, you're going to most likely have a significant amount of additional cash on hand that you may not otherwise have had. And as you said, that's something that we're happy to illustrate for folks on the front end of things before they would actually close.


Kiran Dhillon, SIG Commercial:

Right. And then that cash can be used for things like fixing up the property and adding value in other ways, and then leading you to increase rent. So it's a great strategy to implement.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Exactly right.


Kiran Dhillon, SIG Commercial:

So can you talk a little bit about how well cost segregation works for short-term property holds versus long-term holds, and which scenario it's better for?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Sure. I think we'll make this a as an overriding general statement. We believe that if you are not planning to hold the property for at least five years, then chances are cost segregation is not right for you. And we can speak to why that is in this area of recapture of depreciation, but for long-term property holders, if you are planning to have and hold that property for five years or more. And just as you said, Kiran, if you'd like to have that cash in hand to reinvest and improve that property, or have cash on hand where you close on the first property, and now all of a sudden, if you have a $100,000 - $300,000 or more in cash that you didn't think you were going to have, well, maybe Kiran finds you the next property, and it's an opportunity to take advantage of. So five years or more, without question, five years or less, we would not recommend it.


Kiran Dhillon, SIG Commercial:

Got it. And how long do the tax benefits of cost segregation last?


Joel Dobrin, Cost Segregation Initiatives, LLC:

So the way that cost segregation works is that we'll study the building and we will determine how much additional depreciation, or accelerated depreciation, we can create. That is available to the property owner immediately to offset their income. Now, without getting too deep into the weeds here, so to speak, I would just simply say that if we create say $400,000 worth of additional depreciation, and if the owner only needs to utilize a $100,000 or $ 200,000 of that to help offset their income, then whatever is that remaining balance, it just stays on their books and it moves forward, and it carries forward so that they are then able to use it in subsequent years. So part of the power of cost segregation is, it's there to be used to continue to offset income based on all the other factors that one CPA would utilize in preparing their returns, but when we get to a point of looking to offset income, that's where the power of accelerated depreciation comes in.


Kiran Dhillon, SIG Commercial:

And how long can that additional value that's not taken right away, how many years into the future can that be pushed forward?


Joel Dobrin, Cost Segregation Initiatives, LLC:

There is no time limit. It just continues forward until all of the accelerated depreciation is used up. So some people, large income earners, they may use it up in the first few years. Others that perhaps when all is said and done, and the way they handle their tax situation, if they're reducing income and driving it down, and then they incorporate cost segregation to offset whatever is left, well, they may be able to stretch it out longer. But generally speaking, we have never had a situation where this hasn't proved to be beneficial and provide folks with significant benefit.


Kiran Dhillon, SIG Commercial:

So can you talk briefly about depreciation recapture and how that works with cost segregation?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes. Also, it's another great and important question. And again, just at a high level with respect to recapture: the reason why we say to folks that you want to hold this property for at least five years [is that] any time that someone would sell an asset, you have to pay recapture on the gain of the sale, which is the total sales price, less the net book value. Now, if we increase depreciation in the short term by completing a cost segregation study, they're going to have more recapture since the net book value will be less than what you had if you had not completed a cost segregation study. So this is why generally we advise against cost segregation if you are going to sell that property in less than five years. So if anybody wants to drill into this further, I'm more than happy to speak with them offline, but it is something that needs to be reviewed to make sense and see if it's right for them.


Kiran Dhillon, SIG Commercial:

Okay. So we've talked about a lot of the different factors of cost segregation. So in summary, in which situations does cost segregation work best?


Joel Dobrin, Cost Segregation Initiatives, LLC:

So I think that to really summarize in general: buildings that have building basis greater than $700,000, whether those be newly purchased properties, or purchases that were made within the last seven years. In addition to that, and very, very important, and you mentioned it earlier, is that if people improve their existing properties, and if they spend out-of-pocket more than $300,000 in improvements on an existing property, because of the current rules, it absolutely makes good business sense to see what the impact and what the benefits should be. If you're not making money, if you're not paying tax, or if you want to overpay your taxes, then maybe cost segregation isn't right for you.


Kiran Dhillon, SIG Commercial:

And are there any recent developments in the tax code that have further enhanced the benefits of cost segregation?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes in fact, and it really was just the rules that were put into place back with the Jobs and Tax Reform Act of 2017, along with recent additions to the CARES Act that were put in place just last year. They truly added rocket fuel, is the way I describe it. They added rocket fuel to the benefits that were available to owners, and here's how. As I said earlier, when we go in and we study a building, we look at the 5 year components here, we look at the 15-year components here a little longer.


And prior to tax reform, and prior to the CARES Act, the owner would receive the 5-year benefit over the first 5 years, the 15-year benefit over the first 15 years, still quite a bit better than 27 and a half years. Enter these two recent Acts. And what happens now is for those that have a study done, and they properly document, and can support the moving of these building elements to shorter life periods, what we're able to do is we're able to take all of it, all of the 5-year property, all of the 15-year property, and we just pull it all together and it's immediately available to the property owner in year one. And it just makes the numbers very, very large. And it's been very, very impactful for property owners.


Kiran Dhillon, SIG Commercial:

That's amazing because now all these owners have quite a bit of money, again, to either reinvest into the property, or to purchase more property and continue to build their portfolio.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes. Even, and we'll speak to it, even what's generally considered a smaller property, there's the opportunity for there to be hundreds of thousands of dollars in accelerated depreciation. And if it's a larger building, it literally is millions of dollars in accelerated depreciation. So again, for those that can get their arms around the idea that here I can implement this to keep more cash on hand now, rather than giving it to Uncle Sam, those are the people that say, "Hey, I really do want to learn more about this."


Kiran Dhillon, SIG Commercial:

So there's been a lot of talk with the Biden Administration and the 1031 Exchange being changed, or going away. If something like that were to happen, could cost segregation be an alternative strategy for reducing taxes?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes. And in fact, I would say, absolutely yes, and here's why. First off my partner, Kurt, he is the chairman of the Technical Standards Committee of the American Society of Cost Segregation Professionals, Kurt himself is a CPA, so we're following this very closely. As of today [June 8, 2021], as far as we know, there are going to be no changes to the rules surrounding cost segregation. President Biden is proposing to not allow 1031 exchanges for anything over $500,000 worth of gain. And we think that that bodes very well for us, because if somebody is going to sell an old property, exchange into a new one, and if they have $500,000 of gain on that sale, and if we go in and we then do a cost segregation study on that new property, there's a very good chance that we will create enough accelerated depreciation that it might in fact completely wipe out the tax that they would have to pay on that gain. So we are, I think, in a position where this is maybe an absolute strategy that can benefit owners if in fact this goes through.


Kiran Dhillon, SIG Commercial:

That's amazing. So I guess we will wait and see what happens with that, but at least that's some kind of light, because I know a lot of investors are very concerned about the 1031 exchange going away. So this is a good potential alternative for that.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes.


Kiran Dhillon, SIG Commercial:

So can you share a recent success story that you've had with cost segregation just to illustrate how this works in real life?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Yes, I will. And maybe before I share what is a real life example, I would share, Kiran, that we are very focused on front end due diligence. We do that at no cost. There is no obligation, because we want to be absolutely certain that if we suggest that people look to engage us, we know in advance that we are going to deliver benefit that absolutely makes sense and pencils. If, for whatever reason it would not, we are going to tell folks, we just don't think this is a proper fit. So the owners will know, and we will know what we can anticipate.


So a recent, and I went through just recent projects that we did to try to really hone in on what might be applicable for your audience so to speak. And actually, if anybody is interested just to get an idea of the type of building, I went online and I saw there was enough information, enough visuals, enough pictures for people to see. And this was a multifamily unit. It was located at 929 South Townsend Street in Santa Ana. And if you Google that, you'll see the property, people will know and be able to relate to it, I think, because of the, both the interior and exterior elements. Now, the owner of that building, we were able to study that property, and I probably should also note that Griselda De Mel, who was the banker here, suggested this to their client. And it was because of her recommendation that they went down the path because this was something that was new. And as a result of us performing this study, when we finished our work, we accelerated $425,000 of depreciation that they were able to utilize in year one.


So think of it this way, if they are in a 50% tax bracket, that means that we were able to save them $213,000 in tax. If they were in a 40% tax bracket, it would be 10% less, roughly a $190,000, 30%, etc. But the bottom line is that it was just a very, very powerful result for the owner who turned out was he was a terrific guy and we were pleased to have the opportunity to work with them.


Kiran Dhillon, SIG Commercial:

That's amazing. So how long does it take for this whole process from the time when somebody reaches out to you and then to complete the study and to implement everything that needs to be done?


Joel Dobrin, Cost Segregation Initiatives, LLC:

That's also, it's a great question. So generally speaking, what we'll do is we'll get just some general information on the property: property address and the month and year that they purchased the property. If they have an appraisal, that's always a great source of information for us to be able to drill in and get a sense of things there. We'll put together our benchmark overview and our illustration typically within no more than a week's time, typically less. And if somebody designs that they'd like to proceed and move forward, then generally speaking, it takes us between four and six weeks to do all the needed work, to present to the client a certified and stamped cost segregation study, which includes our full breakdown and essentially rebuilding the building piece by piece.


We also, regardless of where it is in the country, we physically travel and we do a site inspection, we have a site survey team that's dedicated that does these inspections, so that we're able to gather a tremendous amount of digital data. And then we put together these reports and we deliver them to the client.


So the other question too, because I'm sure it's in people's minds, well, what does this cost to do? And I would say this, that generally speaking smaller properties that we're going to take a look at, they're going to be somewhere in the $6,000 - $7,000 range to do the work, and up at the higher end, typically usually no more than $25,000. And that would be for an extremely large, large property. We did, not too long ago, a manufacturing facility in Rancho Cucamonga that was over 180,000 square feet. Something like that was on the higher end. We've done some very large apartment buildings in the San Fernando Valley, hundreds of units, similar situation, but that's generally the range and it falls in-between, and it's based on the size and the complexity of the building, the amount of information that the clients have. And again, we're very upfront and transparent about how we're going to go about our process and what costs are going to be entailed. Our fees are all inclusive, there's no after the fact surprises. The other important thing is that it's a tax deductible expense. So everybody always likes that as well.


Kiran Dhillon, SIG Commercial:

That's fantastic. So for our listeners who are interested in getting in touch with you either to learn more about some of the topics that we've touched on today, or maybe to have you do an evaluation, what's the best way for them to do that?


Joel Dobrin, Cost Segregation Initiatives, LLC:

Well, certainly we are, in this world that we live in of emails and texts and all that, if people want to pick up the phone, I'm happy to talk to folks. My phone number is (805) 680-3834. Also, our website is www.costseg-pros.com, or you can email me at joel@costseginitiatives.com. I'm happy to answer questions. And, of course, anyone that's affiliated with you, my time is theirs.


Kiran Dhillon, SIG Commercial:

Thank you, Joel. And thank you so much for sharing all this information. I know when I first learned about cost segregation, it was like a world of opportunity opened up. So I hope that a lot of the listeners are able to digest this information and gain something from it, I'm sure they will. So thanks again so much. I really appreciate you coming on and sharing your knowledge.


Joel Dobrin, Cost Segregation Initiatives, LLC:

Kiran, it is my pleasure. And as our friend and colleague, Gary Bregman has said, you are a rising star, and that you surely are. So thank you very much for having me. I really do appreciate it.


Kiran Dhillon, SIG Commercial:

Of course. Thank you, Joel.


*This episode is for informational purposes only. Speak with your CPA/tax advisor to see if cost segregation is a good fit for you.



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