JF2175: Understanding Depreciation With Natalie Kolodij
Natalie is the CEO of Kolodij Tax and Consulting, and she is also a real estate investor herself. She uses her investing experience to help other investors out in the tax world. Natalie gives advice on how to determine depreciation and shares examples of what you should specifically do.
Natalie Kolodij Real Estate Background:
- CEO of Kolodij Tax and Consulting
- 6 years of real estate investing experience
- Started off flipping mobile and manufactured homes
- Based in Charlotte, NC
- Say hi to her at: https://www.kolotax.com/
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Best Ever Tweet:
“Depreciation is where most people make mistakes.” – Natalie Kolodij
Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless This is the world’s longest-running daily real estate investing podcast where we only talk about the best advice ever; we don’t get into any of that fluffy stuff. First off, I hope you’re having a best ever weekend; because today is Sunday, got a special segment for you called Skillset Sunday and here’s the skill. It is a skill of, well, helping address one of your, if not the, biggest expense that you have, which might likely be taxes. Today we’re gonna be talking about depreciation and we’re gonna be talking about depreciation with Natalie Kolodij. First off, how are you doing Natalie?
Natalie Kolodij: Good, Joe. How are you?
Joe Fairless: I am doing well. Natalie is the CEO of Kolodij Tax & Consulting, she’s got six years of real estate investing experience. She started off flipping mobile homes and manufactured homes; she’s based in Charlotte, North Carolina, and the topic today, as I mentioned earlier, is talking about depreciation. So first off Natalie, do you want to give the Best Ever listeners a little bit more about your background? And then we’ll get right into depreciation and some things to look out for and some common mistakes people make.
Natalie Kolodij: Absolutely. So I got into tax and real estate at the same time. Got out of college, ended up doing exactly what I tell people not to do, which was I paid for one of those weekend guru seminars. So that wasn’t a great start, because it turns out it is actually a little harder because they lead you to believe, but that led me to–
Joe Fairless: Imagine that.
Natalie Kolodij: Yeah, it’s so weird. I paid them and they told me it was easy. That’s crazy.
Joe Fairless: Don’t tell everyone. That will kill their business model.
Natalie Kolodij: Yeah, pretty much. [laughs] So I was determined to make something of it though. So we decided to think outside the box and that’s how we got into mobile homes, and we ended up– at that time, I was in the Seattle area, so a high-dollar, competitive market, and so we were looking for blue ocean strategy doing something everyone else wasn’t. So we started doing a little bit of marketing and setting up some searches for mobile homes and parks, and we ended up–
Joe Fairless: Who is we?
Natalie Kolodij: Just one of my friends and I who I’d gone to the seminar with.
Joe Fairless: Okay.
Natalie Kolodij: Yep. So we ended up buying the first one off the MLS. It was listed. But the thing with mobiles is they cost people money. A lot of the time they’re holding them, they’re paying lot rent. If they’re age-restricted, they inherit them, they can’t live in them. So it’s not looked at as this asset to pass on like a house. It’s like a car, but if you had to make the car payment, but couldn’t drive it. So they’re really easy to find deals, and you can do a lot of creative stuff with them. The last one we bought, we paid $50 for. So if you’re looking for a good way to get started, I can’t say enough good things about mobile homes.
Joe Fairless: What’s the business model with that $50 purchase?
Natalie Kolodij: That one we bought for $50 came to me from an RSS feed search where pretty much I had a search set up for any mobiles under five grand kind of thing, and so I got the alert. She inherited it, thought it needed a ton of repairs, didn’t want to deal with it, was paying $400 a month for it, just wanted it gone. So we bought it, we put our sign in the window, and it was literally sold that same day. There was someone– it was in a highly desirable area. She had just been wanting to move out there to be closer to the grandkids. So she was ready to buy it. When she found out it would be renovated, she was even more excited. So we literally bought it and had it under contract to sell in the same 24-hour span, and then we had 30 days to finish the renovations. That one got a fair amount of work – subfloor flooring, drywall, a lot of the cosmetic and wear and tear upgrades on it.
Joe Fairless: How much all in and how much you sold it for?
Natalie Kolodij: That one was purchased for $50. I had just under $5,000 in renovations and it was sold for right about $18,000.
Joe Fairless: Wow. So the woman who put it under contract saw it in its original condition, and she agreed at that point in time to purchase it for $18,000?
Natalie Kolodij: Yep, knowing it would be updated… And that was tricky for me because I didn’t know what I had to do to it yet. I only owned the thing for 14 hours, but at that point, I felt like I had enough of a spread that — you can pretty much buy a whole new mobile home for $18,000, so I knew that could be good, but having it sold and knowing we didn’t have to worry about that was the best part of it. Like I said, highly desirable area, highly desirable park and I would say with mobiles, that’s your hardest selling point, is where they’re located. The park, the manager, how strict their guidelines are; that was one of the things we ran into with an earlier home. Why it was hard to sell was because their minimum tenant requirement was so high, their credit score income requirements, it ruled out a lot of people. So you’ve got to find a park that’s easy to work with where it’ll be easy to sell the home. The actual home itself is almost the less important part of the deal.
Joe Fairless: Well, why wouldn’t she just buy a brand new one for $18,000?
Natalie Kolodij: Because most parks don’t have spots anymore. So in a lot of the bigger city, the mobile home parks, they’re getting rid of them, a lot of places. So existing parks have the homes in place, but there’s not a lot that are moving in new homes, just because they’re running that risk of being zoned out or grandfathered out eventually.
Joe Fairless: Okay. Well, you are the CEO of your own tax and consulting business. What’s your background with taxes?
Natalie Kolodij: Yes, I went to college for five years and graduated with a degree in tax, worked for high-end CPA firms for several years… And I love it, I love tax, but what I found was, especially with real estate, it’s an area that gets ignored a little bit. Especially when it’s passive investors, there’s not the same amount of attention and strategy put towards those clients. It’s looked at as, “Oh well, you just collect your rent, there’s not much to do with it,” and that’s absolutely not the case. It’s a huge tax advantage area. So having someone who specializes in it can really, really put you in a good spot. It’s always just super frustrating for me to hear, because I feel like a lot of investors, they forge their own path. They’re sometimes taking money out of a normal retirement account, they’re making these big decisions and manifesting their own destiny for lack of a better word, but they’re doing something that’s not the norm to give themselves more freedom, and then if you go to someone who’s not putting in that same amount of effort as you are, it’s just impeding your goals. So having someone who really gets real estate and is on that same page as you and really will help you make the most of your taxes and keep the most money in your pocket, that’s who you want to work with.
Joe Fairless: You said you have a degree in tax. Is that the actual degree?
Natalie Kolodij: No, it’s imaginary. It’s from Pretend Degree University. [laughs]
Joe Fairless: I thought it was like accounting. I didn’t know there was a tax– what was your major? Is Tax the actual major?
Natalie Kolodij: Yeah, for Master’s degrees, it is. So you can get–
Joe Fairless: Oh, Master’s. Got it.
Natalie Kolodij: Yeah, for a four year– Yep, so anyone who goes the CPA route has to have a fifth year of school, and you get either an accounting or tax specialization.
Joe Fairless: Alright. Well, it shows my ignorance. I thought everyone got the accounting degree. I didn’t realize there’s another–
Natalie Kolodij: It’s a little bit of both.
Joe Fairless: Alright, fair enough. So let’s talk about depreciation and some of the common mistakes that you see being made that come through your door.
Natalie Kolodij: So depreciation, just a quick background, is when you buy an asset, anything for your business that’s going to make you money over a long period of time, the IRS says, “Well, we’re not going to let you write it off all at once. You’re going to be using it for 30 years.” So write off a little bit each over the span of its useful income-producing life. So for residential rentals, that’s 27 and a half years, and the theory is that over that time, it should go down in value. You using the item, like a car gets worth less the longer you own it. We all know that’s not often true with houses, but the tax law is what it is. So when you buy a property, you get to depreciate it, and what that means is, when you buy it, you get to separate out the value of your land versus your building. Land doesn’t depreciate, you don’t get to; that just stays the same for millions of years. So you figure out your building value, and then you get to deduct it over 27 and a half years, and the reason this is so beneficial is that it’s an expense, it’s something you get to write off on your taxes, but you didn’t actually have to write a check to get the deduction.
Most of your write-offs you do, like you get to deduct insurance, you have to pay for that. So depreciation means that at the end of the year, you can make money. You can have $2,000 sitting in the bank that your rental made, but on taxes, if your depreciation is then a $5,000 deduction, it’s going to take your taxable, your paper income, what you’re showing, it’ll reduce that $2,000 by that $5,000, and on paper, you show a loss of $3,000. So it’s really important, because it’s what lets you make money, but not pay taxes on it, and then potentially use any leftover loss to reduce other income.
Common mistakes we see are people not separating out their land value; that’s really important. You can’t just depreciate the total price you paid. The land isn’t allowed to be depreciated. So something that’s important is that you’ll hear even tax professionals say, “Oh, we use an 80-20 rule. We just automatically put 80% to building.”
Joe Fairless: It’s got to be more precise.
Natalie Kolodij: That’s imaginary. Yeah, that’s not anything– that’ll never pull up an audit.
Joe Fairless: Like your degree. Just like your tax degree.
Natalie Kolodij: Just like that. That’s where you learn that rule, actually; that same place, that imaginary University. [laughter] So you can’t just pick an arbitrary number, but there are seven different allowable ways you can use, and most people don’t look at any of the other options. So what I tell people is, as a start, you have two really good options to look at. Look at the county assessor, you’re going to look at their percentage they allocate to land versus building. You don’t use their actual numbers, you just apply that same percentage to what you paid… Because I don’t know if you’ve noticed this, the county assessor is often nowhere near what the house actually costs.
Joe Fairless: Right.
Natalie Kolodij: So you just use the same split pretty much, 50-50, 40-60, whatever it is. The other option that you’re allowed to use is your appraisal, and oftentimes, an appraisal is more beneficial; they just tend to allocate less to the land portion. So I always recommend at least comparing those two options or talking to your accountant about looking at both options, because most accounting firms only just pull the county website and use that number and don’t look at anything else. So since you have a few different choices, you might as well compare and see which one puts you in the best position and gives you the best deduction.
Joe Fairless: Okay. So make sure we separate our land value, because we have to. Those are the rules. Okay. What if you don’t? What’s the consequence?
Natalie Kolodij: Potentially is if you get audited, they’re going to correct it and you’re going to end up paying back that excess depreciation you took on the land all at once as a result of that audit. The other thing with depreciation that’s a little weird is when you sell, you have to recapture it and pay back that tax. So pretty much the best way to describe that is, like I said, when you think about a car, it becomes worth less and less over time; that’s why they let you have this deduction. So when you go to sell and if you make money, the IRS is like, “Well, hold on. We let you deduct part of this every year because it should be going down in value, but it went up in value. We want that back.” So they tax it at 25%. So, if you don’t separate out your land, it’s going to be wrong for all those years. It’s probably gonna look wrong to lenders when they look at it, and it’s incorrect. You’re gonna get nailed in an audit, and the thing with audit is that it opens up a Pandora’s box. So if they find that one big red flag, they can now dig into every other little detail of your taxes.
Joe Fairless: Plus, correct me if I’m wrong, but wouldn’t you get fined? You’d have to pay interest on whatever money you should have paid initially to the government?
Natalie Kolodij: Yeah, having an audit go negative, go against you, puts you in a bad spot. So it’s gonna end up– you can be penalized for it depending on if– especially if it was like on purpose. If someone purposely did it, there can be additional penalties on it. So just yep, as a rule, you can’t deduct the land portion, you can’t depreciate that. So we’ve got to separate that out… But make sure you’re doing it in the smartest, most advantageous way you can.
Joe Fairless: By looking at the county assessor website and using the percentage they use, or looking at your appraisal.
Natalie Kolodij: Yep, I would start with those two.
Joe Fairless: Okay, that’s one mistake. What’s another mistake?
Natalie Kolodij: Another thing we see a lot is that if you do any big renovation on a property, like you buy a rental, you put 50 grand and you do the whole studs out renovation on it, they’ll literally just add that whole amount to the value of the property, and depreciate it over 27,5 years. And that’s fine… It’s not incorrect, but there’s quite a bit of things we can separate out from that, even without doing a formal cost segregation, which is where you separate out every component of a house. Just on a normal renovation, your accountant’s allowed to separate out especially things that aren’t attached to the house. So it’s important to, when you do a renovation, track your projects, essentially what it’s made of and what those costs were, because things like appliances, carpet, any land improvements, potentially kitchen cabinets, and counters – these are all things that can be separated out into a shorter life. So we can call those a five-year-old asset or seven-year asset or a 15-year asset. And what’s important is that anything under 20 years qualifies for something known as bonus depreciation, which is a freebie from the IRS that says, “Well, its life is short enough. We’ll let you write it off in this one year.” So your $50,000 renovation, if half of it was your appliances, carpet, cabinets and landscaping, we might be able to deduct $25,000 all in one year, instead of spreading the full $50,000 across 27 and a Half.
Joe Fairless: Will you elaborate more on bonus depreciation?
Natalie Kolodij: Yeah. So it is a rule the IRS has that says that — it used to be only 50%, but this was a change with the Tax Cuts & Jobs Act. So pretty much any asset that has a life of less than 20 years can potentially utilize bonus depreciation, and it’s just an option provided by the IRS that lets you deduct the whole value in year one instead of having to depreciate it over five years or ten years or whatever the life is. You just get to deduct it all in the first year.
Joe Fairless: What are some examples of assets that have lives of 20 years or less?
Natalie Kolodij: Your appliances, your computer, if you have a home office setup to manage your rentals… Something we see missed a lot is land improvements, which would be like if you put in a new retaining wall, you put up some landscaping. Land improvements are all 15 years, so as soon as you do anything on the outside of your house, keep that in mind, because there’s a good chance we might be able to use that as bonus depreciation.
Joe Fairless: Any other mistakes that you’ve seen that are common when factoring in depreciation?
Natalie Kolodij: Those are the big ones. The other one is just be careful of your date. I just reviewed a return done by a professional where they put everything in service. The date– the partnership was set up not when they actually bought the properties. So the date you get to start depreciating assets is when it’s purchased or when it’s in service, so it starts getting to do its job. So if you buy it, but it’s not livable at that point, you don’t get to depreciate it until it’s in its functional state. So just be aware of the dates you’re using as well.
Joe Fairless: Natalie, thank you for being on the show. How can the Best Ever listeners learn more about what you’re doing?
Natalie Kolodij: The best way to find me is you can find me on my website, it’s called kolotax.com; that’s a great way to find me. I’m also on Facebook at Kolodij Tax – The Real Estate Tax Strategist. So either of those places is a great way to find me and reach out and get a hold of me.
Joe Fairless: I enjoyed learning about the depreciation and the three common mistakes that you’ve seen, but then also the mobile home snippet that we talked about in the very beginning. Just learning the business model, a bonus on top of this episode, so thank you for that… And I appreciate you being on the show, enjoyed our conversation, learned a lot. I hope you have a best ever weekend and talk to you again soon.
Natalie Kolodij: Alright. Thanks, Joe. Have a great rest of the week.
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