Episode Transcript:  

  It's been all over the headlines causing a lot of controversy. But one thing that isn't controversial is that the big, beautiful bill is really good news for real estate investors. We're gonna learn what's changed and how it will impact you. On today's episode, let's get ready to scale.

Hey guys. My name is Jeannette Friedrich, director of Investor Relations here at Blue Lake Capital, where we specialize in multifamily investments across the us. Joining me today is Jason Melilllo. He's the CEO of KB Kg, an accounting firm that's. Specializes in tax credits, incentives, and cost recovery.

Prior to that, he was the CEO at crossed CPAs and consultants. He also has a very impressive background in volunteering. He's a board member at five Acres b and b. An organization that supports vulnerable children and families through foster care, mental health services, and family preservation programs.

In addition to that, he also serves as the executive committee VP at the Pasadena Tournament of Roses. He helps to organize the Rose Bowl parade as well as the Rose Bowl games. So that's. Super cool. He has a bachelor's in finance from the University of Southern California, Marshall School of Business, and he is joining me right next door somewhere here in la.

So Jason, welcome to the show. 

Thank you very much for having me. I'm glad to be here. 

We're thrilled to have you on, especially now more than ever, as we're looking at the passage of the big beautiful Bill. But before we start to unpack all of that, can you just explain to us what is cost recovery and where is a place that people often accidentally leave money on the table, if you will, by overlooking this, key strategy?

Sure. Cost recovery and depreciation is something that most people in real estate have a pretty good understanding of. But it, it can get a little bit nuanced at times. And so what we live in is the nuance and figuring out how to optimize the amount of deductions that people would get for their real property that they're renting and trying to mitigate taxes or reduce their income so they.

Pay the least amount of taxes that they're entitled to pay. 

Music to my ears and everyone else's also. I'm sure. So speaking of reducing taxes, let's jump into the big beautiful bill that has passed now. What are some of the key areas that you think are most pertinent to real estate investors that you know have changed?

Because I think that it's overwhelming. There's so much information about it. Yeah. I think that, this is the information that's most vital to people. 

Yeah. For real estate investors and real estate owners in particular, the, probably one of the biggest impacts or the big beautiful bill is the return of bonus depreciation at a hundred percent.

Bonus depreciation was, kind of stair stepping its way down from a hundred percent it had gotten down to 40%. It, it is now backup effective for 2025 from January 20th on. And I'll explain what that means and how that works. But when someone owns a piece of real estate, they buy a piece of real estate and place it in service.

Any assets that meet a shorter life, definition for depreciation can qualify for this bonus depreciation. So if someone's purchased a piece of real estate that they're renting out typically if it's multifamily, it's gonna have a 27 and a half year life for depreciation purposes. And all depreciation is the recovery of that capital.

Investment over the statutory life. So you get to deduct that one 27th of the building value over the life of, or over the time that you hold it each year, one 27th or 27 and a half year depreciation. Bonus allows you if you do a cost segregation study, and that's one of the things that we do.

Cost segregation allows for the investor to. Bifurcate that building into shorter life property. So if you think about a typical apartment building, you might have cabinetry in the kitchen or certain types of floor coverings light fixtures, exterior land improvements that would qualify for shorter life, those items that qualify for the five and seven year lives, and even some of the 15 year life property.

Can qualify for bonus depreciation. So that means that if you pay a million dollars for a property and you end up with $300,000 outta that million in short life bonus depreciation allows you to expense that in year one. That's where and we'll make the math simple. If you pay 270,000 for something, you would normally depreciate it $10,000 a year, if that's your depreciable basis with the bonus depreciation, whatever portion of that 270,000 that you move into the short lives.

So if it's a hundred thousand, you get a hundred thousand dollars. Deduction not a $10,000 deduction because of the bonus. Yes. So that's the power of bonuses. You really get that year one bump and it gives people flexibility. If they have a portfolio of properties, maybe they want to sell a property and just take some cash and put it into some other type of asset class other than real estate.

So they're not doing a 10 31 exchange. And if they do this cost segregation study with a bonus on a newly acquired asset that allows them to take that other asset that they may be selling. And, and not end up paying a huge tax bill. So it's a planning opportunity and it's just a great tool to have in the toolbox for the investor and their tax professional.

So bonuses is great. How, and Jason, 

Let me just throw a tidbit out there for the listeners. Sure. In plain English, this is that beautiful loss that we see on our K ones particularly the first year that we purchase a property where you see the nice, huge, negative number that, can scare people sometimes, and it when it's misunderstood, but it's effectively the loss that we're able to capture to offset any of those passive gains that you're getting through distributions, et cetera.

Throughout the holding period of the the property. Now, I do wanna, before we unpack some other things, I do wanna point out to people how and why I will always recommend having a CPA filing your taxes because it's complicated and you really wanna make sure you understand, these critical components that are represented in the K one essentially.

But next year, when it comes time for people to file their taxes, if insanely enough, they're trying to do 'em. Themself, which again, I don't recommend. How does it work with the cutoff date? So are you gonna suddenly just capture 40% depreciation from January 1st to January 20th and then, apply a hundred percent thereafter?

Is that how jinky the math is gonna get next year? 

That is exactly what's gonna happen if it was placed in service. On or after January 20th 2025, then the a hundred percent bonus depreciation comes into play. If it was prior to that, then it's under the old rules. And that's what's interesting about this bill, there's all kinds of different dates for when something is effective, when it phases out.

And so it, it does create a little bit of, craziness around just trying to keep track of what, what's happening. But there's lots to unpack and there's lots of good stuff in here. There, there's some give and take to be honest with you. One of the areas that some real estate investors benefiting from were.

Around green energy incentives. The 1 79 D deduction, which is energy efficient building deduction, and that is for basically developers or real estate investors that have improved or built a property that meets certain energy efficient criterion. This. A particular benefit is in addition to bonus and it's up to a $5 81 cents per square foot tax deduction in year one as well.

And that would apply to things like HVAC systems lighting the building envelope. And this is sunsetting now. It was permanent but under the big beautiful bill, it is now sunsetting. For any property not started by June 30th, 2026. So if you have somebody starting construction as long as construction starts by June 30th, 2026, they can still get this additional tax deduction, which again allows you to front load more deductions.

And here in California it's much easier to meet these thresholds for energy efficient buildings. Because our rules are so strict here in California relative to some other parts of the country. It's just easier to qualify. It still requires certain improvements and certain criteria to be qualified.

But that deduction, much like the bonus is really nice for people who are spending money on a development or on improvements that meet those standards. 

Very interesting. So what else can you unpack for us that is of, great interest to the majority of the real estate community here?

A along the lines of energy efficient in addition to that. Building deduction. There's an energy efficient credit. This also is previously existing, but also now has a shorter life. And this is the pay for, this is how some of the other benefits. By bringing bonus back in, they've gotta take some things away to pay for these things.

The 45 L tax credit was a credit of between $2,500 and $5,000 per. Dwelling units. So if you're building a 100 unit apartment building and you meet these criteria, it could be a $500,000 credit Wow. For the investors. If it meets certain energy efficient construction requirements if it meets the Energy Star program or if it meets this Zero Energy Ready Home program, it's 2,500 for Energy Star and.

And 5,000 for the other. Just so it's again, for construction that starts, before May 12th, 2025. If someone's already started construction, they could still get this benefit and these dates are all based on when the government disclosed that there's going to be a change.

So Interesting. The January 20th date was the date that President Trump gave his address to the United States and Congress, and he talked about bonus depreciation being a hundred percent. That's why that. Is now the date that we use is, that was when it was disclosed. And then the 45 l change, that's when the house bill was originally published.

And so a little inside baseball for your listeners interest. Interesting about how these dates get selected. 

Does this include something he puts out on truth social as well. We can have a random date from that also.

I don't know that qualifies as official government publication, you never know.

I know it. Another area, this is a benefit so I gave you a couple of takes and now I'm gonna give you a give. So the business interest. Deduction limitation. So this is for your real estate investors that are leveraged and they've financed their purchase. The rules that were instituted back in the Tax Cuts and Jobs Act of 2017 limited your deduction to 30% of a certain number so that if you're, if your interest was 350,000. And your EBIT number, your earnings before interest and taxes was a million dollars. Your threshold for deduction was 300,000. 30% of that number. And so you would not get to deduct the three 50. You would only get to deduct $300,000 of interest. Now they've changed the formula under this new law to ebitda.

So you get to add depreciation back in the calculation. So if your depreciation was a million dollars in my example, and you were a million. For the depreciation, bad add-back. Now you've got a $2 million number to put, apply that 30% to, which gives you 600,000. So your $350,000 interest deduction is deducted in full.

So it's a, again, a really esoteric aspect of the law. But, people who were financing. Projects, we're not getting a hundred percent of the deductions for the interest they paid. And, that's hard. It's paying, it's like having a higher interest rate.

I, I think people understand that they know if I'm paying 6% versus 4% for something. But if you're paying 4% for something, you think you've got a great interest rate on this property that. That you're financing, but your interest deduction is being limited and it's really costing you closer to 6%.

And so it, it it's one of those hidden gotchas that sometimes get people in the tax world. 

Interesting. And, forgive me if this is a juvenile question, but it may be a benefit for someone out there, that I ask it. So can this also be applicable in the scenario of someone being considered for tax purposes, a professional real estate investor or, a real estate professional, as they would market that has taken the financing strategy approach for their positions in various investments.

I like to say that the real estate professional is the golden ticket. It allows for your listeners, it allows someone who has losses from their real estate activities to offset those losses against other ordinary income. So it could be against other investment income.

It could be against wages earned from a spouse or some other activity. It converts it from a passive activity to an active activity. Unfortunately, this business interest deduction 1 63 j does not allow for someone who's a real estate professional to take the full percentage. It applies to everybody.

That is certainly one of the things that it, it makes it easier now by adding back the depreciation to the calculation. That's significant because when you think about somebody who it is the first year and they've got all this bonus depreciation, they're losing a certain amount of that interest deduction in the old calculation with the new calculation.

With all that, it doesn't even, it doesn't even affect it, there's a much less likelihood that they're gonna be impacted by that business expense, business interest expense deduction limitation. 

Interesting. Very interesting. And what does it just, since we, dipped our toe into the water, what does it take for someone to qualify to get that per se golden ticket of being a real estate professional?

Typically they have to spend 750 hours a year on their, in investment activities relative to real estate. And they also have to spend more than 50% of their time. So if you think about somebody who. They, maybe they're a doctor and they own a bunch of rental properties, and they say I spend 800 hours a year on my real estate business.

But if they spend 900 hours a year on their medical practice, they don't meet that threshold. It has to be greater than 50% of their time. I and I always encourage people, keep good records, you know when you are a real estate professional and you're getting if you've got a property you place in service and you get a million dollar loss because of the depreciation that's flowing through, that's gonna attract somebody's attention at some point.

Always just have good records to protect yourself. 

Yeah, absolutely. And an interesting but not fun fact is that not even I qualify because it is technically, quote my day job. And so because it's my day job as an employee of the company, even I cannot be considered a real estate professional for tax purposes, 

right?

So what a lot of people encourage. Their spouses, if they're heavy invested into real estate they encourage their spouse to maybe participate as a real estate professional by helping to manage the properties and perhaps get licensed because that is. It is meaningful. If you've, especially for a higher net worth people, if you've got somebody who's making a million or $2 million a year in ordinary income from their job or their profession, and they can generate a million or $2 million a year of tax losses from depreciation and wipe that out as a real estate professional, that would be incredibly meaningful.

And that's why a lot of these laws are designed the way they are, because. Certainly the real estate lobby is very good. And the people who invest in real estate have learned along the way that they can literally go through life and never pay taxes. And I suspect that's why years ago when a lot of people were trying to get their hands on our president's tax return, that there was such a big fight against that because, a anyone in my position that knows real estate and taxes understands it.

Most real estate professionals don't ever have to pay tax because they're good at what they do. They're gonna be able to continue to buy properties and wipe out any income. 

Wow, fantastic. Sounds like I need to go home and have a very persuasive conversation with my husband about how he spends his time.

Exactly. 

All right. Jason, what other goodies do you have for us? 

So there's a few other things in the bill. There is an business expense deduction. This section 1 79 and this. Typically applies to equipment and it allows for a two and a half million dollar deduction. So when you think about bonus depreciation it's the same kind of idea as bonus depreciation.

And so in most cases, bonus depreciation is gonna be more valuable than. Business expense deduction. But there's one or two little instances where some assets in real estate might not qualify for bonus depreciation, but they will qualify for this section 1 79 deduction. Interesting. And so it, it might be certain HVAC upgrades or fire protection equipment alarm systems and things like that.

Even roofs might meet that. Threshold. So it just, I think that the key is to know that when talking to your tax experts, just to make sure that they're looking at this stuff on a almost a line item by line item basis, to, to ensure if you're. Working with someone and you do a cost segregation study on a property, you're gonna be able to allocate or bifurcate those assets to what the tax preparer will be able to see.

Okay, this is something that meets the threshold for bonus. This is something that might meet that threshold for section 1 79 business expense. 

Very interesting. 

It's a little, unique at times, but that's the way the tax code is. You have to, I always like to say you eat around the edges to, to reduce that number.

And, everywhere you look, if there's an opportunity, you take it and and the next one this is something that applies not only to real estate, but anybody with a flow through entity. And this is the qualified business income deduction. And it's known as Section 1 99 A for those keeping score at home.

And this is a 23% tax deduction on your flow through income. So if you have a million dollars of flow through income from your. K ones or from your real estate activity, you get a 20, a $230,000 deduction off the top, no questions asked. So it's like a big rate break on the top tax rates because now you're gonna get taxed on 770,000, not a million.

So it's about an eight and a half percent break. Instead of paying 37% at the top tax rates, you're gonna be at 28.5% for federal significant. And this I'm happy to say was fixed because a lot of professionals were limited in this benefit over the last number of years. It was a new part of the tax law from 2017 and it almost excluded explicitly attorneys, doctors, accountants, engineers, consultants, financial advisors, any of the professions. It basically limited how much you could benefit from it to the point where most people didn't get it. Interesting. And I'm happy to say that our lobby finally did it their job and got this passed so that it applies to everybody now.

So it levels the playing field. It was designed to, to. It's, it because it's for flow through entities. It was designed to level the playing field for C corporations or, the big Fortune 500 type companies. And the typical investor that has maybe an S-corp or a partnership or some sort of flow through activity because the tax rates are substantially lower for corporate tax rates.

And so in order to level that playing field they added this benefit. Like I said, for the last, six or seven years, it's not applied to to most of the professionals. So nice to have that. Nice to have that. So again, for real estate investors, I'm sure that, with a lot of family office investors that listen.

They've already fully depreciated a lot of those properties that have been in the portfolio for years and years. This is a benefit where they're actually getting a 200 and or 23% deduction from the real estate income that they've got on those K ones. Which, is significant.

Absolutely. 

This one is great for taxpayers in the high tax states. So California, New York, New Jersey. This is the pass through entity tax deduction. If you recall from the Tax Cuts and Jobs Act of 2017, this was a big thorn in people's sides. The salt cap when we, when we could no longer deduct state taxes and.

Over the next couple of years, a lot of state legislation passed laws that said, we'll allow you to pay your state tax for your flow through entity, at the entity level and issue out a credit, a state tax credit to your investors, partners and owners so that they get the tax. Credit and a deduction for paying the state tax through the entity level, a federal deduction.

So it was a workaround that the states and I wanna say something like 40 states instituted this type of deduction. Interesting. And the federal government has preserved and continues to allow this now that, investors can continue to do this pass through entity tax deduction. So if you think about it in California, for example where the top tax rates are 13.3% and the pass through entity.

Tax deduction is 9.3%. So on a million dollars, someone who has $133,000 of tax, state tax, they can deduct and under the old, rules, they would only be able to deduct 10,000 on their individual tax return if they didn't do this past serenity deduction. With the past Serenity deduction, they can do a $93,000 deduction at the entity level.

They get a $93,000 tax credit passed out to them so that they get that credit on their tax return, but they get that $93,000 deduction, which is worth about a $35,000 tax benefit for federal tax purposes. So a huge, phenomenal Yeah. Benefit. And then just to circle back to the, to the salt cap that was also increased. So on an individual tax return, they can now take up to $40,000 of tax deductions for state taxes. So again, for the real estate owners that pass through entity deduction is significant because again it's real dollars. 

Yeah, that's very good news to everybody listening, especially those of us here in California and the other, high tax states.

Yeah. Agreed. 

Yeah. And then last but not least is the clean ener or clean electricity production credit. This is you think about like solar credit, a lot of, solar farms have sprung up over the last number of years because of the credits that existed. So investors were being attracted in with, lucrative deductions and credits that could be passed out to them.

This again, as part of the Inflation reduction Act that was created under the Biden administration the Trump administration under the big beautiful Bill is using this as a way to pay for some of the other things. So these benefits are gonna go away in 2027. They still will exist because you've got a lot of institutional investors or that have created these funds to build these solar farms.

And it's not just limited to solar, it's other, we'll call it green energy type renewable energy properties, so that's gonna go away. But not for a couple of years. 

Interesting and a bummer for those that are locked into those types of investments for the benefit of, being able to have that credit.

What a bummer. But nonetheless, I, it is interesting to see the give and take that had to come about in order to restore the benefits that we do get. And it definitely is great news for. Insurance excuse me, for real estate investors all around. Now, I did wanna ask you I was thinking about insurance, so I did wanna think, I did wanna ask you a question about basically wildfire insurance in particular, especially here in California, shot up like astronomically by 20% this year, right?

And and of course we're not the only one. This is becoming a very cons. System issue across the United States. As we continue to have more and more natural disasters, more significant natural disasters, so I'm just curious to know. When it comes to being able to capture write-offs, through cost segregation studies, which upgrades are actually still going to be quote worth it, fire resistant roofing upgraded electrical systems, et cetera.

Is there anything that's changed in regards to that or that is hopefully motivating? Or creating, I should say, some type of workaround to help offset the premiums that are being associated with the insurance cost. By being able to leverage some type of additional strategy on the backend that can write those costs off.

Yeah. So there are certain there's nothing in the bill that, that addresses this, but yes, I agree. This is a significant issue for real estate investors across the nation. Whether it's the floods or the fires, the hurricanes, all kinds of stuff that's happening. That I think the people who still have insurance are lucky to.

To 

have it even at a much higher percentage, but to someone who's doing some sort of upgrade, let's say that they're putting on an exterior sprinkler system onto their properties to, to cover roofs and things like that there might be, certain items that are picked up under a cosec study that allow for shorter life.

Typically when you think about something that is permanent attached, it's part of the building itself like a roof that is real property. And sits in that bucket of the longest life asset. But other elements of the building would qualify for shorter life, just depending on what it's used and how it's used.

If someone were to swap out a roof there, there might be a case for writing off the existing roof and capitalizing the new roof. Again, if you have that cost segregation study, that'll break down the. The value of the old roof. So you can see how much that write off would be to dispose of the old roof.

Interesting. Interesting. I just, while I had the opportunity to be talking to A-C-P-A-I, I always take full advantage of it. Sure. So I had to see what your perspective was on the insurance premiums and how difficult they're making. Deals when it comes to trying to pencil deals, it's making deals very difficult to do and we've gotta figure out some good strategies and solutions, to work around that.

But very good. Now, Jason, before we move into what I call the lightning round questions, which are just five questions that I ask all the guests on this show, is there any other, last takeaway or key key piece of advice that you'd like to share with our listeners today? Given all of these changes happening.

I would just say that have that conversation, sit down and talk to your tax professional. Make sure that they're looking at it holistically to, to cover everything. There's a lot here. Everyone is learning about this at the same time. And especially, and it's and it really is new for 2025, so many people are probably gonna be preparing and filing their individual and flow through tax returns for 2024 over the next few months.

As we approach the final deadline there, this does not apply to 2024. So it, it's really 2025. But as you're thinking about estimated taxes and what you would pay toward your estimated taxes for 25 here in California, for example, because of the fires, there was that extended due date for everyone's estimated tax payments and taxes due.

So most people in California or certainly in the LA area haven't had to pay their estimated taxes for 25 yet. And there's an opportunity there to look at what. Properties they may have placed in service for 25 under the new rules they can lower before they even have to pay their first estimated tax payment lower to what their expected taxable income's gonna be.

Very interesting. All right. Alright, thank you very much Jason for helping us to try to decipher and wrap our minds around all that the big, beautiful bill entails. All in all we will take the wins where we can find them and there's a lot of wind in there. What I'd like to do now is ask you, our lightning round questions.

So when you're not, reading really boring tax code, papers and having to work on Excel spreadsheets, what do you actually do for fun? 

I like to play golf. I like to travel, so I would say that's my way to relax. 

Nice. Nice. Very good. And what is something interesting about you that most people don't know?

Okay. So people who know me well know that I'm a father of triplets. Oh, wow. So that's a little bit unusual. And then the other thing this is also a little bit of a hobby. As my kids were growing up I took my boys and I would do a trip every year and we visited all but three of the major league baseball stadiums.

Ah, very cool. So's little, something interesting. 

Yeah, that is fun. Very nice. All right, and then what is far, what about as far as a podcast or a book would you recommend is worth a read for people that are trying to really get a better handle on maybe tax structures or, investment strategies, ways to reduce, taxable burdens.

Anything along those lines that you think has been helpful? 

I, gosh I wouldn't recommend any books for taxes. Just, there is nothing interesting there, to be honest. But just as, as far as podcasts go there, there's some very heavy tax. Space podcasts again, that I think, is interesting for CPAs and folks like that.

And from an investor standpoint, I like the all in podcasts. Yeah. I just find it interesting. I think, it's always topical. They mix in some politics and economics in there. So I think from just getting some good information in a little bit of insight is helpful.

Yeah, absolutely. I think we all wish we could hang out with J Cal,

yeah. 

And go to the All in, conferences. Yeah, exactly. Yeah. Uhhuh for sure. Alright one of the things that we talk about on the show also is, yes we wanna make money and we wanna have good investments and good returns, but the point of it all is really about trying to build and live extraordinary lives.

So what is your advice for someone that's focused on doing that? 

Living an extraordinary life. Certainly people who invest in real estate the people that I know that have invested in real estate, they live a great life. They have the time to enjoy other things. And I have a very close friend of mine who's a real estate investor and my, my daughter stayed with him and his family one summer when she was working back east.

And she said, you need to have his life because he works a couple hours in the morning and then he is able to go play tennis or golf in the afternoon. And the people I know that have been, diligent about investing in real estate and building a portfolio. It really does afford you the opportunity to, take care of business in, whatever time it takes, but then you have a lot more time to, to spend, to do, pursue other interests.

Yeah. Very true. Very true. All right, then last but not least, if folks wanna get in touch with you, if they say, Hey Jason I need a CPA. 'cause I just got overwhelmed even listening to us talk about this. How can they find you? 

So I can be reached on LinkedIn? Jason Mallow they can email me at Jason dot Melillo, M-E-L-I-L-L o@kbkg.com and I would say also they can visit our website, kbkg.com. We actually have a product that, software product that people who invest in multifamily properties for rent, if they want to do a cost seg up to 1,000,002 in basis, they can do a cost eg through our software product. Otherwise, we can certainly help them.

With a a larger property, a larger scale property through our engineered methods. But if anyone that's a listener, we have a promo code ready to scale 2025, that if they enter that they'll get a 10% discount on the software use.

We certainly appreciate that. Thank you Jason.

Welcome. We'll be sure, welcome to include your contact information, that promo code and a link to that software in the show notes. So thanks very much. 

Yeah, you bet. My pleasure. 

I really appreciate you breaking down the latest and the greatest for us today and sharing your insights. Thank you very much, and for those of you that invested your time with us today, thank you.

I appreciate it. Please make sure to leave us some comments. Let us know what else you'd like us to dig into, and in the meantime, be bold, be extraordinary, and keep moving forward. Ready to Scale is brought to you by Blue Lake Capital, where we hunt down the best multifamily investment opportunities that we can find and invite investors to join in with us.

We target class B value add multifamily properties across the Sunbelt. Our CEO Ellie Perlman, invest a substantial amount of capital into every deal. This means our interests are aligned with yours. If you're an accredited investor looking to expand your portfolio and diversify sponsors, be sure to visit us@bluelakecapital.com.

Blue Lake Capital, be bold, be extraordinary, and keep moving forward.