How to pay no taxes on Millions in Real Estate Income

The beauty of depreciation, cost segregation, and bonus depreciation in Real Estate.

The U.S. is an amazing place that rewards people who take risks and create businesses. Our system greatly incentivizes Entrepreneurs, Investors, and Real Estate Owners.

For some reason, they don’t teach these concepts in our school system. And it’s a huge mistake.

Not until I began seriously focusing on investing in different asset classes did I begin to understand how impactful tax advantages can be. The importance of understanding the tax system and applying it to your personal situation can be worth tens of millions of dollars per year.

With a deeper understanding of how to use our tax system wisely, I have been able to buy apartment complexes that provide me with cash flow … and then for tax purposes, I can actually show that I lost money, which results in paying no taxes (and sometimes even receiving a credit)! For example, last year my properties were able to generate millions of dollars in cash flow, but on my tax return I was able to state that I lost money. I’ll explain to you below how I did it. I can’t use actual numbers or my lawyers will kill me, so I’ll provide you with broad examples.

So, how does this work? It works by implementing two very simple things: 1) Depreciation and 2) Cost Segregation.


Depreciation is a tool used to show you what the current value is of an asset. Let’s use a very simple and generic example: let’s say I bought a Tesla in 2019 that was worth $100k. We have agreed that the useful life of this car is 5 years. In order to understand the current value of the car we will take the beginning value divided by the number of years in the useful life to calculate how much the car’s value has depreciated. We’ll take $100k divided by the useful life of 5 years, which result in a depreciation amount of $20k. So after 1 year, that Tesla is now worth $80k. This is called straight-line depreciation. There’s a lot of different ways to calculate depreciation based on the type of asset you’re depreciating, but the constant will generally always be the useful life of the asset.

In Real Estate, depreciation is typically calculated based on a period of 27.5 years for Residential Properties and 39 years for Commercial Properties. I’ll use the example of apartment complexes since that is near and dear to my heart. Let’s say I buy an apartment complex that is worth $50M. Now all the residents in that apartment complex pay me $5M in rent for the year. After I pay all my property expenses and my mortgage, I have about $2M left over in cash flow. In a different world, I may need to pay taxes on this full $2M. Taxes on this large of an amount could be close to $1M, wiping out 50% of my gains. This is where things get interesting. By using depreciation, I am now able to subtract the depreciation amount of the property to state what my cash flow is for tax purposes. Using the 27.5 year useful life of a Residential property, that depreciation amount is calculated as follows: $50M Property Value / 27.5 year useful life = about $1.8M. That means on my tax return I will say $2M Cash flow - $1.8M depreciation = $200k Cash flow! Amazing. I am now going to pay taxes on $200k and the additional $1.8M I made will be shielded from Tax. Taking an average 35% tax rate on that $200k equals $70k in Taxes. That’s much better than the almost $1M I would be paying in Taxes without using Depreciation. Ultimately, this means I paid $70k on $2M in Income … a 3.5% tax rate.

But wait, there’s more! There’s a way to reduce this taxable income even further.

The way to do this is through Depreciation’s best friend: Cost Segregation.

Cost Segregation

Cost Segregation is an analysis that allows you to include all additional assets related to the property and then separate each of them in a line item format to calculate the useful life of each item.

The analysis is performed by a specialized firm that has experience in Tax Accounting, Construction, Architecture, and Engineering.

This can be confusing, so let me explain it simply. When I buy an apartment complex, I don’t just buy the buildings — I buy everything that comes along with the building. The carpeting, the ventilation system, lighting fixtures, phone system, computers, and so on. I also end up buying new things for the property and doing renovations. These additional items will be categorized as “Personal Property” and “Land Improvements”.

Instead of just using the total property value and dividing it by a useful life of 27.5 years, now I am able to “segregate” every different item that is on the property and reduce my useful life. For example, the computer might have a useful life of 3 years, which is much lower than the 27.5 years for the buildings. This means I have a higher numerator (property value + all the other items on the property) and a lower denominator (useful life), which equals a higher depreciation amount.

But wait, there’s more! There is something else from the IRS called a Section 179 Deduction, which states that you can take a bonus depreciation of 100% in the first year on these additional items in Cost Segregation. What does this mean? That means that I can take the ENTIRE amount of the depreciation on Personal Property and Land Improvements in the first year of owning the property. Lets go back to our example of the $50M property we purchased and look at what we’ll pay in taxes using Cost Segregation vs. using Straight-line Depreciation.

When using Straight-Line Depreciation, I take home Real Cash flow of $2M and declare $200k of Taxable Income. With Cost Segregation, I take home the same $2M in Cash Flow, but I am able to declare a loss of almost $10M. This, my friends, is the beauty of Real Estate and our tax system.

Now, before you start frantically Googling Cost Segregation companies to perform an analysis on your house or rental property, keep in mind that these studies usually cost anywhere from $5k - $15k. From a financial perspective, it probably won’t make sense to do this unless you have a large amount of Real Estate holdings. If you’re invested with someone who has these holdings and you’re receiving cash flow, make sure they are doing Cost Segregation.

Knowing the tax system and how to use it wisely can be the difference between compounding your wealth in the range of millions of dollars.