The Rental Property Tax Strategy Most Real Estate Investors Are Missing

Michael Hoffman (00:00)

In a residence, just single-family residence with a cost basis of half a million dollars, depending on what year you place it in what time of the year you place it into service, straight-line depreciation might allow you fifteen to twenty thousand dollars. Okay. Sounds great. I take twenty thousand dollars, apply it against my taxes—not so bad, right?

But that same property, through accelerated depreciation—cost segregation—could get you anywhere from one hundred and forty to one hundred and eighty thousand dollars of depreciation first year.

Scott Bursey (02:07)

Welcome back to the Real Estate Pros Podcast, powered by Investor Fuel. I’m your host, Scott Bursey. And today we have an absolute industry veteran, Michael Hoffman of Cost Seg Property, joining us. With over 40 years of expertise in residential development, Michael has transitioned his seasoned background into founding a powerhouse cost segregation firm based in Colorado Springs with a national footprint. Pros, get ready to dive deep into how his precise analysis is helping investors achieve massive reductions in their tax liability. Whether you’re in a long-term or short-term rental space, this conversation is going to be a game changer for your portfolio. Michael, welcome to the show.

Michael Hoffman (02:56)

Well, thank you, Scott. It’s a pleasure to be here.

Scott Bursey (03:01)

And to help our listeners get up to speed, please give us the ninety-second highlight reel of how your career ignited and where you’re pouring your fuel now.

Michael Hoffman (03:12)

Well, I always had a passion for construction. I was a young kid, and s-and someone actually gave me a job on a construction site and handed me a hammer, and it just opened the world. And they taught me how to frame houses. Did that for a number of years and finally convinced somebody to hire me for an indoor job, and that started a—literally a forty-year career path that I was blessed to have employment by some of the major groups out in Southern California.

And I think the pinnacle of that was being director of operations for a a residential firm that—we did about 2,000 houses a year. So it was quite an exceptional opportunity and truly a blessing to have all of that background. But eventually, the entrepreneurial spirit hit me, and I had to go out on my own. So I left this very well-paying and rather envious position to go out and go walk and roll around on the dirt again and build houses. And that transitioned to starting two different companies in Colorado, and combined we did, I don’t know, probably fifteen hundred to two thousand homes and lots over the years.

So it was, again, just really a blessing to have that opportunity. But about three years ago, something came across my desk, and it was this thing called cost segregation, accelerated depreciation. And I read it, and I immediately, Scott, thought it was a scam. I said, “There’s no way that the government would allow this to happen.”

And so I called a couple of my people and my—I’ll use an ancient term—Rolodex, right? So, my contact list, and spoke to them, and no one knew much of anything about it. And to me, again, that just created opportunity. So I plugged into to the people that knew more about it, learned about it, and said, “This is something that I can see myself doing, my latter years, after a great career, that benefits people.”

And that’s really what it’s about, is having an opportunity to present something that isn’t—well, you like I’m selling draperies. It’s gonna cost you a thousand dollars for those draperies, and when you’re done, they’re worth a thousand dollars.

Yeah, we sell—essentially, we are salespeople. We sell a product that’s that creates incredible opportunities for our clients. It’s typically one based on their tax savings. We’ve had clients—thirty X return on what they spend for a study—that they’re getting, decreasing their liability to the IRS. And to me, that makes it beneficial to people.

I’m not saying, “Here’s—give me a thousand dollars, I’m saving you a thousand dollars.” Give me a thousand dollars, I could save you eighty thousand dollars. And to me, that’s rewarding because we we see our clients take the money, use it judiciously, invest in new properties, increase our portfolios.

And we have a lot of discussion about generational wealth. We have some associates within the company that are enrolled agents, financial planners, property managers, and we plug them into that network. And it’s just been amazing to see what some of these clients have done in just the last couple of years, and buying new properties and increasing their portfolio. And it’s just very rewarding. It truly is.

So that’s kind of the elevator pitch now. And as as to cost segregation, it’s an IRS-approved methodology. It’s been around for almost 30 years. And it’ll actually—it all started back in the ’60s when the economy was bad, and the government came out and said, “You know, we need to allow people to depreciate property.” Okay?

And it was just—and that that was straight-line depreciation. So you take you take what the cost basis is for the property, which is what you have in it, less the value of the land, and then you divide it by twenty-seven and a half years, and that’s what you’re able to write off. That that was it. Now we’ll just talk—today we’ll talk residential, so it’s twenty-seven and a half years. Commercial and industrial is different.

But—and that went along great until about thirty years ago, and someone came to the IRS and actually sued the IRS and said, “You know, we appreciate the fact that we can depreciate—sorry for the pun—but there are elements within our houses that aren’t gonna last twenty-seven and a half years. Our flooring’s not gonna last. Our appliances don’t last. Even the concrete going up our driveway isn’t gonna last twenty-seven and a half years. They just don’t. Things wear out. The roofing isn’t gonna last. So we have to figure out a way to to address that.”

And so what they came up with was accelerated depreciation. We call it cost segregation. And what that allows you to do is to take those elements in your house that that aren’t gonna last the 27.5 years and accelerate the depreciation on those, and still recapture or retain that—the 27 and a half year property as well, right?

So by doing that, it creates a massive difference. And just give you an example, in a residence, just single-family residence with a cost basis of half a million dollars, depending on what year you place it in what time of the year you place it into service, straight-line depreciation might allow you fifteen to twenty thousand dollars. Okay. Sounds great. I take twenty thousand dollars, apply it against my taxes—not so bad, right?

But that same property, through accelerated depreciation—cost segregation—could get you anywhere from one hundred and forty to one hundred and eighty thousand dollars of depreciation first year.

Okay, now you just go, “Well, I don’t make $180,000.” Here’s the good part: it rolls over to the next year. So whatever you don’t use, you don’t lose. You just take it year to year, year after year after year. And again, you don’t lose the—that other twenty-seven and a half years. So it’s always feeding you more.

And it’s just it’s just amazing to to see when the light clicks on with a client and they go, “My gosh, that means that I don’t have to write that that, you know, five-digit check to the IRS. I can take that money, I can apply it towards another investment,” and you’re going, “Bingo. You got it. That’s it.”

Scott Bursey (11:17)

Michael, that was an incredible breakdown. And building on that, curious to know, looking at your strengths in the market, what do you think is the biggest misconception residential investors have about cost segregation?

Michael Hoffman (11:34)

Well, I think primarily is that there’s just a lack of education. I mean, I get in front of groups of realtors. W-we like to go to their weekly or monthly meetings, and a lot of them, even in the Springs, have essentially massive meeting rooms. And I’ve stood before, you know, fifty to eighty real estate professionals—these are brokers and agents—and I always ask the same three questions.

Or I I ask them, you know, “How many people here know anything about cost segregation?” And maybe 10 to 15% of the hands will go up. Okay? I said, “Well, how many of you actually use a cost segregation—cost segregation study?” And all the hands go down.

And then here’s the big question, Scott, and this this is pretty funny. It’s, “How many of you own rental properties?” All of the hands in the room go up. And you just think, in the back of my mind, I’m going, “I thought the bright people were coming to the meeting.”

Because look at as a real estate professional being in the business, they can take that entire first—I mean, all of their income can be written off by a cost segregation study. And that’s pretty impactful. I know that that when I first heard about this, after I realized it wasn’t a scam, that it was IRS-approved—it’s just another methodology of depreciation on a property—first thing I did was call my ex-CPA and go, “Why didn’t you tell me about this?” Right?

And he goes, “Well…” He’s just kind of, you know—I, we’re talking on the phone, but I imagine at that time he just kinda looked at the floor, and, you know.

But they just don’t know. They just don’t have the knowledge. So a lot of what we have, I I don’t think there’s any real misconceptions other than people, “Well, it’s a scam,” or, “It doesn’t work for me,” or, you know, they just don’t know. It’s just the knowledge. So that’s kind of the key to what we’ve done with our business, is just get the word out there all the time, you know.

Scott Bursey (14:18)

Michael, what is the most common roadblock you see investors hitting when they try to implement cost segregation on their own?

Michael Hoffman (14:32)

Well, a lot of them—gosh, that’s a great question.

I think that it’s that they don’t understand—first of all, they don’t understand cost segregation, and then they’re not thinking clearly about what the benefit would be to them. And so a lot of times, we do a free estimate. It’s a four-page worksheet that shows them, kind of outlines their property, and and shows them year to year what the accelerated depreciation be.

And what’s nice about our estimate is it compares it against straight-line depreciation. So it shows that delta, right? And you go, “Okay, so here you’ve got a straight line. This is what you get. Here’s what you’re gonna get.”

And then the last part of it is a chart that shows each year what it is. And then, based on what we’re estimating their overall tax bracket liability is, then it shows you their actual cost savings. Once that starts clicking in, and then they start mentally applying it, it’s great.

But it isn’t just what they don’t know about, but it’s also that there’s things that we can do that can help them from their past taxes. Okay. So let me let me give you an example of that, because this is this is kind of an interesting thing, is that we—well, let me back up.

Have a client in Colorado Springs. He called me last April or so of twenty four and said that he had fifty properties, and he wants me to look at all of them to see which ones be decent for cost segregation. And we came back and we said, “Twenty-four of—okay, twenty-four out of the fifty work.” The others he had held too long. They just didn’t have a cost basis, and I’m not gonna trade dollars with a client. Okay?

I’m not gonna say, you know, “You pay us for the study, and that’s what you’re gonna save.” I want it to be multiples of what we do. And so, we weeded out about half the properties, and we started—you know, we signed the contract, started working on the deal, and we’re a couple of weeks into it, and I had them on the phone because we had some questions about one of the properties.

And he says, “Boy, you know, Michael, I gotta tell you, this is really a godsend because I’ve been paying so much in taxes.” And it clicked in my mind, “Well, my gosh, I—you know, this is something I didn’t even think about with this guy.”

But bottom line is, he had a lot of these properties back in the—you know, in the last couple of years. He had these properties, and we can do a go-back study, okay, placed back into service back in those years, and then you go back and you amend his taxes. Okay?

So, just cumulative total of everything that happened to this gentleman—and he’s he sent us another half dozen more studies this year—but out of those studies we did, this cumulative total was three million dollars in depreciation. Three million dollars in depreciation. Okay, now remember, he’s a real estate professional. That’s three million dollars he’s not gonna pay tax—I mean, that he can earn, he’s not gonna pay taxes on.

Secondarily, went back, amended his taxes for two years, clawed back from the IRS three hundred thousand dollars. Okay, now, we did all this for a base fee. We don’t—we don’t, you know, charge—our charges aren’t based on what you save. We just have a flat fee for everything.

And so his return on investment was a hundred times. I know, it’s crazy if you really stop and think about it. Needless to say, I’m definitely on his Christmas list. You know, he sends me a card now, so that’s good. But, you know.

Scott Bursey (18:31)

Interested to hear from an operator—let’s go down the road of opportunities here, Michael. With the current landscape of short-term versus long-term rentals, where do you see the most untapped potential for tax savings right now?

Michael Hoffman (18:46)

Well, the short-term rental—and that’s a good question—because short-term rental, through the eyes of an R—through the eyes of the IRS is—it becomes a commercial property. Okay?

So when we do a cost segregation study—yeah, it’s a single-family house. If you did it as a long-term rental, we have twenty-seven and a half years. If it’s done short-term, it’s thirty-nine years. Okay. Now, that doesn’t change a whole bunch. Okay? It really doesn’t make that much of a difference number-wise.

But it is interesting because the IRS looks at short-term rentals as commercial properties because they say you’re providing services that you wouldn’t provide long-term. Interesting. Now, that just kind of came into effect, and it hasn’t been tested yet. I know a couple of enrolled agents that that look at it a little differently, and they’re putting out—we’ve done some cost segregation studies, they they’re putting them out there, hopefully.

And I hate to tell—did I just say hopefully? My gosh. Possibly one of them will get audited. Okay? And by the way, we offer free audit protection because we know what we’re doing. You know, our numbers are correct. We don’t get into gray areas. But if one of those studies get audited, it’ll be interesting to see how the courts rule, right? Because—’cause I think they’re wrong. Most CPAs and enrolled agents think it’s wrong.

But the other opportunity for short-term rentals is that the qualifying hours to become a real estate professional are a fraction of what they are for i-if your portfolio has long-term rentals. So that’s the other ability that that people with a couple of Airbnbs or that type of thing, they can qualify as a real estate professional with much fewer hours.

And I gotta tell you, I think that’s wrong too, because—because my wife has owned a couple of different Airbnbs. She had a a very large house down in Belize and a couple of properties in Florida, and she worked around the clock.

It’s—Airbnbs are—you spend a lot of hours managing Airbnbs, but they’re phenomenally profitable. I have a lot of clients call me. I had just one this—just yesterday. Today’s—gonna say Monday. They bought two new properties down in the western side of Florida—Southwest Florida—eight hundred thousand and a million one, and they’re both gonna be short-term rentals. So and the and they cash flow. So it’s a great opportunity either way.

Scott Bursey (21:34)

Thinking about the threats in this economy, how are you advising your clients to navigate shifting tax regulations while still maximizing their property performance?

Michael Hoffman (21:46)

Wow. It’s—you know, a lot of a lot of what’s going on is locally. It’s not it’s not nationwide. You know, you’re seeing a lot of individual jurisdictions create—or even states create—laws that are are so in favor of renters, and frankly, they’ve almost written the law to discourage investors and the desire to have rental properties.

And then you get—a lot of jurisdictions have said they’re licensing short-term rentals, they’re creating caps on how many short-term rentals can be in their community. And once you once you have that that, you know, the golden ticket, you can really capitalize on that.

But I don’t—but that’s at the exclusion of everyone else, and that’s wrong. That’s not what the free-market enterprise is supposed to be. We’re supposed to—you know, this country is founded in free market, and we don’t need the government trying to figure out, how we should do our businesses. Let it—let us succeed and fail on our own. But they—

Yeah, I don’t think it’s necessarily the interest rates or tax rates, because we can make your tax rate go away. But I think it’s more just the individual jurisdictions, and sometimes states, creating problems that make it difficult or impossible to try to do business with them.

Yeah, look at—look in New York City right now, what’s going on with their rent stabilization. And, you know, you have people just selling pro—people that have owned properties, have, you know, for thirty, forty years, are having to get out of the market because somebody’s decided that they need to control their business. It’s just, you know, it’s all right. It’s not what we’re founded on.

Scott Bursey (23:34)

That all of our pros would like to know from you: What is one major strategic move an investor should make today to ensure they aren’t leaving money on the table at tax time?

Michael Hoffman (23:52)

Well, first of all, I—and this sounds very self-promoting—but do a cost segregation study on it, on whatever you have. Okay? Make sure that either you or your spouse can qualify as a real estate professional.

Okay, if you have a couple where one of them is W-2 and the other is handling the investments, that’s a perfect situation. Because, you know, that that individual is handling the investments can qualify as a real estate professional, and by—just through their all of their income is offset by that cost segregation study.

I think that’s that’s the number one thing, is getting your tax base down to zero. There’s other ways. I mean, you can move to Puerto Rico. There’s there’s lots of things you can do to avoid taxes. But if you’re focused on being here, do a cost segregation study, because I really consider that to be the other side of the equation whenever you’re analyzing properties.

I think a mix of short- and long-term rentals—I I’ve analyzed some clients’ portfolios with them—that seems to be a good strategy as well. And—but I would suggest not to be the person that that tries to manage them and cleans them and does all that. Hire a management company.

It just—you won’t believe all the hours that the operational side of a short-term rental, how that can impact you. It’s well worth hiring a company to take care of that.

Scott Bursey (25:24)

That is a pro-level takeaway. Thank you for dropping that knowledge, Michael. And for those of our listeners that want to keep this conversation moving, stay in your lane, or collaborate with you on future deals, perhaps, what’s the best way for them to reach you?

Michael Hoffman (25:40)

You can reach us through CostSegProperty.com, or you can call us direct: 719-551-2020. And the 2020 is because we have great vision.

But another thing too, if you have a clientele—any investors out there that actually have a business and have a business property that they do their business out of—there’s a way we can restructure their company to separate the business from the asset. And we we do it through through different LLCs and a trust.

By separating that and having the income come into the trust, and then do a cost segregation on the asset, have the depreciation come into the trust, it’ll offset the income to—their—for their company. And we’ve worked with a number of businesses throughout the country that that have that situation, and we’ve saved them hundreds of thousands of dollars. So that’s another kind of cool pro tip, or whatever you want to call it.

But just another strategy, and there’s a lot to it. There’s so many different ways you can do this and apply it that—the IRS, I mean, it’s codified. It’s—they actually have names for that. So, yeah, there’s lots—lots of different strategies you can use.

Scott Bursey (27:01)

Michael, that was an excellent additional golden nugget. And thank you for joining us today on the Real Estate Pros Podcast.

Michael Hoffman (27:10)

Scott, it’s been my pleasure, and I look forward to hearing from your clients and seeing if we can help them with their tax liability. It’s truly my pleasure.

Scott Bursey (27:22)

And to our listeners, we appreciate you. If you receive value from today’s episode, please subscribe. We’ll be fueling your tanks with the lineup of elite guests, just like Michael Hoffman, who are accelerating and setting the pace for the rest of the industry. Until next time, keep your standards high and your vision clear. We’ll see you in the next episode, everyone.