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In this episode, Wes Read walks dentists through one of the most powerful and underutilized tax strategies available to building-owning dental professionals: cost segregation. With a focus on education and practical application, Wes explains how the two-entity structure (dental S-corp + real estate LLC), combined with a formal cost segregation study, can generate massive upfront tax deductions that accelerate wealth building. He covers the fundamentals of depreciation, the mechanics of cost segregation, real-world examples, and what to watch out for.
Practice CFO Background & the Wealth Advisor Model
Wes explains how Practice CFO was built as a fiduciary-based firm integrating CPA services with financial planning, specifically designed for practice-owning dentists to accelerate personal financial independence.
The Three-Pocket Framework
Every practice-owning dentist operates across three financial entities: the dental practice (S-corp), the building LLC (real estate), and personal finances. Understanding cash flow across all three is the foundation of advanced tax planning.
What Is Cost Segregation?
A formal engineering and accounting study that reclassifies building components from the standard 39-year depreciation schedule into shorter 5-, 7-, or 15-year asset classes—dramatically accelerating tax deductions.
Depreciation 101
Wes explains straight-line vs. accelerated depreciation, asset classes (5-year, 7-year, 15-year, 39-year), MACRS depreciation schedules, and how bonus depreciation allows dentists to take significant deductions in year one.
Real-World Example: $2M Building
Using a $2 million dental office as a case study, approximately 30% ($600K) is reclassified, enabling a potential $200–400K deduction in year one when paired with bonus depreciation—at zero additional cash outlay.
Front-loaded paper losses, offsetting rental income, building real wealth via appreciating assets, lookback studies for existing buildings, and estate planning advantages through gifting LLC interests.
Depreciation recapture (25% federal tax on sale), passive activity rules limiting loss deductions against active income, and the requirement to use a qualified cost segregation firm ($5–15K study fee).
Wes Read: Welcome back everybody to another episode of the Dental Boardroom podcast. You know, a subject that's come up many times over the years that doctors oftentimes wanna learn more about is something called cost segregation, and let me explain what that is. Cost segregation is when you use the relationship between the building that you own and practice in, and the rent you pay from your dental business generally in S corporation.
These are typically two separate entities. Now I'll explain why they should absolutely be separate entities and also a strategy that can save significant amount of taxes to build your net worth. As you know here at Practice CFO, we are first and foremost wealth advisors. We are attempting in every way we can with every strategy we can, with deep engagement with our clients to help them grow their personal balance sheet.
Their personal balance sheet is different than their business balance sheet. Business balance sheet is gonna show your business checking account. It's gonna show your dental chairs, it's gonna show the goodwill if you bought the practice. It's gonna show your debt for the practice and your credit card, any equipment, loans.
That's your business balance sheet, everything you own and everything you owe inside of your practice. And the difference is called your book equity Between those two numbers, a low accounting 1 0 1, your personal balance sheet. Is actually the thing that will sustain you when you are no longer working with your hands for income, IE passive income, and the point at which you can comfortably step away from putting in time and skillset to generate income, to take care of your life.
And you can step away from that and live off assets that are producing income, such as rental income, interest income, dividend income, capital gain income. When you get to that point, you can live off that comfortably with a good cushion for down markets and potential negative scenario. You know, you've achieved financial independence.
When I started practice CFO, everything I did was just about personal financial planning. In fact, I didn't even do the CPA work. This was 13 years ago. Well, about a year later, I realized that for me to be a deeply effective financial planner, an advisor for my dentists, I needed to have a, an influence on the CPA side of their life.
IE in the practice, I needed to be able to have balance sheet and income statements in the practice to give me a visual x-ray of the numbers and then to structure the cash flows in the practice to optimize the output to the personal balance sheet. And that's where most of the hard work is, to be honest.
A financial planner for a dentist who doesn't understand the pumping heart of their cash flow, which is their dental practice, is gonna do something extremely basic. They're gonna tell you using a simple software, which does all the work in a couple minutes, how much you need to save to set aside for your retirement.
If you want to retire at age, I don't know, 65 and live off $12,000 a month, all in, that's a very easy projection. And typically what financial advisors do out there is they will then try to sell you on a product. They'll do that little analysis, build some trust, and then boom, they will drop a cash value life insurance policy, or they will drop an annuity or something that pays a backend commission to them.
Why? Because they don't have most of them a fiduciary obligation to put your interest ahead of theirs. Something I'm vehemently opposed to. And so when I started practice CFO, it was under the model that we are a fiduciary for our clients, meaning li legally we are required to put their interests ahead of ours and we have certain licenses, the CPA license, I have the certified financial planner license, and then there's some investment, uh, licenses.
As well called the Series 65, which is needed to be able to provide financial advice. But all of those put a discretionary and better set a fiduciary responsibility on us to put clients' interests first. So that's where the model of practice CFO came to be. A fiduciary based financial advisor with a CPA backend to give the financial x-rays to create a global financial plan for a practice owning doctor to accelerate their financial independence.
In a nutshell, that is the Anatomy of practice, CFO's background and how it came to be, and I absolutely love now that I'm. 14 years, 13 years owning practice CFO. Since I started it, loving to see the incredible results coming out of effective planning that my team here at Practice CFO is doing all under one roof.
It's just such a joy to see their personal balance sheets grow so quickly and fill that financial organization and confidence. It can be, it can be ruy, it can be bumpy at times for sure, and building wealth and. Making financial decisions and learning along the way. It's not always a smooth ride, but constant engagement and moving that needle is what gets it done.
Alright, let's jump into the subject this time called cost segregation. And the reason why I gave that, um, intro is to highlight that there is a close relationship between the different financial entities of a practice owning dentist. There is the dental practice. There is if they own, their building should be a separate LLC, and then there's their personal life as well.
Three pockets in a way on the same person. And there's incredible amount of control on navigating cash flow across those three entities to saving in taxes and to accumulate wealth faster. Well, this one is kind of a cool strategy now. If you don't own your building, then this doesn't apply right now.
However, if you're a client of practice CFO, you know that our philosophy is we would like you to own your building. Preferably, as long as you don't pay an outrageous price, which would then reduce or eliminate the return on that investment. So if you can buy it at a fair market value, typically speaking over the life as a practice owning dentist, you'll be better off financially by owning your building and paying yourself rent rather than paying into somebody else's personal balance sheet.
Why not pay into your own? So cost segregation highlights this unique relationship between those doctors who own their building and they own their practice. So I'm gonna now share my screen. For those of you who are watching on YouTube and I. I will narrate it. For those of you who are not, and just listening on your phone, if you don't have this on your phone, I'd love for you to subscribe both on YouTube and here you'd be doing me a huge honor.
Thank you very much. Okay, so this is called, um, cost Segregation, how dentists can use their building to slash Their Tax Bill. And we'll talk about cost segregation, a two entity structure, and really what is an S corp strategy for tax mitigation. Now, I do need to emphasize for all you out there, uh, especially if you're not a client of practice, CFO, this episode is for educational purposes only, and this is not something you should try at home.
So make sure you consult a licensed CPA and attorney before any implementing this type of strategy. Okay, let's go into the first segment, why dentists are perfectly positioned to, uh, use a cost segregation strategy to mitigate their tax liability. Number one, dentists continue to have predictable high income.
Yeah, most of our clients are in the higher tax bracket and in the higher tax bracket, it becomes exceptionally painful as a huge friction in your cash flow and building wealth to pay high taxes. Dental S Corps generate strong recurring revenue, exactly what lenders and tax planners love. You're already in the right income bracket to maximize this strategy.
And I say lenders there because generally speaking, you need a lender to buy your building. Another reason you're already paying rent. Most dentists pay rent to someone. The only question is whether that someone should be you. This strategy lets you redirect that money to build your own wealth. And the last reason that I have on here is two entities.
One strategy. Your dental S Corp generates a K one income. And if you've listened, all my podcast and I will repeat certain topics that I think every dentist absolutely needs to know and sort of master around. Finance and accounting. I don't want my doctors to become finance and accounting specialists because that takes a lot of time and time away from the chair is gonna be less productive for you.
But I do want you to know that as an professional corporation, this is for, for those dentist practice owners out there who are not set up as a partnership, which is its own separate type of legal entity. And I did a six or seven part series on that last year in early 2005. You can go check that out if you are a partnership.
Um, but most dentists are set up as an S corporation. Now some states allow you to file as an LLC. But the IRS does not recognize an LLC that does not exist to the IRS. You cannot file an LLC tax return, so you have to choose how your LLC will file. Will it file as a sole proprietor? Will it file as a partnership or will it file as an S corporation?
And if you're the only owner, most of the time. In fact, it should be almost every time you're gonna file as an S corporation. And s corporations are not taxed to the IRS. Uh, C corporations are like Apple and Amazon and, um, all the oil companies and Microsoft, those are C corporations, and they pay taxes like they're a human being.
S corporations don't. Instead, the profit from the S corporation gets, uh, sent out on a document called a K one. And that K one lands on your personal 10 40 tax return, and that's where you pay for it. And that's called single taxation. C corporations pay double taxations 'cause the C corp, like Apple will pay taxes as a corporation and then distribute its profits as dividends, and then the shareholders pay taxes on that.
That's called double taxation. So please don't be a C corporation dentist if you are a C corporation. Talk to your CPA, you probably need to switch CPAs 'cause any CPA who lets you sit as a C corporation for a long period of time is probably not doing good by way of advice. So you're a, a dental S corporation or LLC filing as an S corporation.
You generate this K one document and then separately you have a real estate LLC. Now, I always recommend that your LLC be held in a real, in an sorry that your real estate entity, your building is held in an LLC. And if you own. Different rental properties. Most attorneys will tell you to put each one in its own LLC to silo the liability of each of those properties.
And we don't want your building, uh, entity to be exposed to potential liability inside your dental practice. So a separate real estate LLC. Is set up, which then collects your rent from your practice and uses cost segregation to offset it, reducing what flows to your personal tax return as taxable income.
And that is in a nutshell what is happening here. Now for the next, I don't know, 20 minutes or so, and probably the next few podcast episodes, I'm gonna go much deeper into this strategy, but at a high level, you have these two entities. One is paying rent to the other one. And you can jack up that rent, which then reduces the taxable income on the K one from your dental corporation.
And then the income goes to your building LLC. And the question is, how do you reduce that income so you're not paying taxes on it? Therein lies the benefits of cost segregation, and I'll explain why it's cost, why it's called cost segregation. Okay. Let me just, uh, go ahead and. I'm having some cursor problems here.
Okay, here we go. Okay, let's go on to now. Segment two. Cost segregation 1 0 1. What is it? Cost segregation is the following A cost. Segregation is a formal engineering plus accounting study, and this is something that you have to pay. A firm that specializes in cost segregation. It's not something that most CPA firms do.
When you get to the larger CPA firms like an Ernst and Young or a Pricewaterhouse Cooper, those ones will do cost segregation for sure, inside of their, uh, CPA accounting firm as, as a public accounting firm. However, for small businesses, you really gotta find somebody. This is pretty much all they do.
They just do cost segregation, and there's a number of them out there, and I'm not gonna endorse anyone right now, but just know there's plenty of companies out there who will complete a cost segregation analysis. And what it's doing is it's reclassifying the building components from a single type of depreciable asset into shorter asset classes.
Now to understand this, let me step back and. Redefine for you. 'cause I've, I've done this many times, but you've gotta understand this for me to move on. What is depreciation? Depreciation is the following. When you buy something that provides a value, an economic value to you over a longer period of time, IE greater than one year.
Then what the IRS requires you to do is capitalize that thing that you bought. So let's say you bought a cone beam, a 3D scanner, and let's say you paid a hundred thousand dollars. Gonna use simple numbers here. The IRS says, Hey doc, you're gonna use that over many years. Therefore you don't get the deduction of that a hundred thousand dollars in the year that you bought it.
You have to depreciate that, or better said, deduct it little by little over time. So in that case, it's over a five year period. So you're thinking, well, crap, I just came outta pocket a hundred grand and I don't get to deduct that all in the current year. I have to deduct that over five years. And by the way, it's not equally 20,000 per year in that example.
20,000. 20,000, 20,000, 20,000, 20,000. It's not like that. Instead, it's, uh, it might be 20,000 the first year, 35,000 the next year, 15,000 the next year, 10,000 the next year, and it has this curve that starts off strong and then trails off in the, in the fourth and fifth year, it's called makers depreciation deduction.
That's getting a little too much for you, but just understand that. D depreciation is the IRS allowing you to deduct that cone beam or the dental chairs or the renovations on your building or the new roof or the new hvac, whatever those are that you buy that are big, big expenses, typically north of over 2,500.
And you get a benefit over time. The IRS and your CPA is gonna make you comply with this, uh, makes you deduct that over time so you don't get the tax benefit right away. However. There are a few exceptions, and the exceptions are when the government says, Hey, we want to incentivize businesses to buy more stuff, to buy more dental chairs.
To buy more x-ray machines to buy more of all these things, to keep the economy really flowing. 'cause the more companies are buying and selling, the better the economy is, the more active it is, and the better the GDP and the better the GDP, the better the growth in the economy is and the better the growth the economy is, the better we are, generally speaking, who have investments in that economy through stocks and bonds and 4 0 1 Ks and IRAs and all that stuff.
So the government will will use certain tax incentives as levers to motivate certain behaviors. For example, owning your own house, you get to deduct the interest on your home mortgage, and that is an incentive from the government for you to own your own house. The government has decided that that's a good American benefit, and whenever they feel that way, they will try to provide tax incentives.
Well, cost segregation is one because it motivates business owners to keep investing and buying and trying to grow. And so that's why it exists. And in, in, in this depreciation conversation or concept, you have to understand that the IRS doesn't classify all of these types of things. You buy these, what are called capital assets, like that comb, beam, or like that new roof.
They don't treat them all the same. They're in categories. And common categories are five year asset categories, seven year asset categories, 15 year asset categories, 39 year asset categories, and there's some few more in there, but those are the basic ones. Now, to give you more clarity on what is in each of those buckets in the five year category, what are call five year assets, you have things like specialty electrical, you have plumbing.
You have cabinetry. If you buy your chairs or your cone beam, those are also five year assets, meaning that you depreciate them and get the tax benefit over a five year period. Now, you may be complaining and saying that's, that's, that's too long. I want it now. Well, five years is actually the shortest category.
There is. There's seven year categories. And then there's 15 year categories in, in seven year categories. There's certain clinical equipment that's more structural in the building. I won't go into that one. Honestly. We almost never use that. We put almost all clinical equipment in the five year category, the 15 year categories.
When you start to get into kind of the structural things like parking lots or uh, broad landscaping that's done, or signage, those tend to be 15 year assets. And then the building itself. The shell, the two by fours, the roof at all of the, the building, structural, uh, most fundamental aspects of the building.
Those tend to be 39 year assets and land. Guess what? Never depreciates. You never get to deduct land. You wanna know why? 'cause land doesn't, it doesn't atrophy. It doesn't get old. It's just land. And so the IRS says you have an an infinite lifetime value on that land. It's only gonna go up in price, so you actually can't deduct land.
So when you buy the building, you have to portion some amount to the land and some amount to the structure, and the more to the structure of the building, the more tax deduction you can get. Alright? Dental offices are especially favorable due to the clinical build out. Dental chairs, suction systems, specialty lighting, and operatory walls.
These things all qualify. Now let's look at an example here of a doctor buys their building or they build, they do a. Build out. They buy a shell and do a build out. And this applies to both. Let's say you buy the building that's somewhere around 1.8 to 2 million, maybe it's here in Southern California where prices are a little bit higher.
You might get $50,000, $51,000 a year, plus or minus on that depreciation of the building. So 51,000 times, 39 years, it's little by little. Same amount every year, the 39 year asset class. As the building is, is what's called straight line depreciation. It's the same every year when you buy that cone beam and it's only five years, it's actually not straight line.
It's more in the, in the first two or three years, unless in the last two years. Now with the cost segregation analysis though, instead of that 51,000 deduction in year one, you can get a massive deduction in year one. But what happens is in years two through 39, you're getting less. Tax deduction from depreciation because you accelerated or front loaded a lot of those other years, two through 39 into the first year.
And when you pair that up in that first year, so you, so you move a lot of that depreciation into the first year, you can use this thing called bonus depreciation or certain section 1 79 deductions on some assets. And so when paired with this bonus depreciation in year one, you could potentially deduct 40 to 60% of the amount that was reclassified from the 39 year asset to the five, seven, or 15 year asset.
That's where you get massive benefits from doing this. Okay, let's look at a, an example. A $2 million dental office building the number's at a glance, $2 million. Dental office building, 600,000 of the 2 million. You complete a cost segregation analysis. So you hire a firm, they come in, you got an engineer there, you got the accountant there.
They're putting their heads together and they're saying, of the 2 million purchased price of this building. That the doctor is now operating in, we can reclassify 600,000 of it into these five to 15 year property classes, thereby allowing the owner, the dentist to get more depreciation in those first 15 years.
And that could be up to in, in year one, potentially 200 to 400,000. Now, normally. How much of that 2 million can you recategorize into the other asset buckets? The five to 15 year buckets, it's usually around 30% of the total building value. That's a common rule of thumb. Then that 30%, in this case, roughly 600,000 can be depreciated faster, and when you pair it up with the bonus depreciation, you could get up to 400,000 plus deduction on that.
Now, how much extra cash did you come out of pocket by employing this strategy other than a small fee to the firm for doing that cost segregation analysis, which you need by the way, you need that because the IRS is very keen on looking at these, and if you have a formal study done with a report, these things are usually like, I don't know, 50 to a hundred pages.
They're very therefore de de defendable in the event of an IRS audit. Now the IRS knows that these are very valid, so they're not auditing all of these, but if it looks like it could be a bit outrageous, like you bought a $2 million dental billing and you accelerated 1.7 million of that in year one.
Yeah, that cost segregation analysis is probably overly aggressive for sure. But the reality is, other than paying a little bit of money to the company that does the analysis, you're really out of pocket. This is purely a tax strategy that is, man, it's not manipulated. It is re-routing numbers in a way that benefit you from a tax standpoint that is completely legal, completely.
This is called tax avoidance. It's not tax evasion. You cannot evade taxes. That's jail time. That's penalties and potential jail time tax evasion that is knowingly disregarding and disobeying the IRS code. Tax avoidance is saying, how do I use the code to my advantage to minimize taxes and pay as little as possible, and o essentially only pay what I'm legally responsible for doing in that practice?
CFO. We are always following our motto of towing the line, but not crossing the line. Why? Because yes, we wanna save every dollar possible in taxes, but we also don't want you involved in a messy, long, expensive IS audit. Let's stay out of their cross hairs. Okay, so now that you have the general idea of what's happening with a, with an example, let's talk about the pros and cons of cost segregation, the pros and cons of it.
Um. And I do want to make sure I, I made this very clear what's happening in that cost segregation analysis. I'm gonna go back up here a little bit to the, what is it, 1 0 1. When that study is done, they are dissecting that building. They're going through it. They're looking room by room. They're looking at the wiring, they're looking at piping, they're looking at the way the roof is done.
They're looking at all of the, uh, the, the chairs, all of the x-ray machines, the front office, the cabinetry, the furniture. They're looking at everything that was paid for when the building was bought, and they're saying these. These things that were bought are actually, it's not the building. They actually bought these wirings, or they bought this cabinetry, and this cabinetry is worth, I don't know, $50,000 of the $2 million, and all the wiring back here is worth $25,000 and all this is worth that and that.
And so they're dissecting it into those different buckets. And then each bucket is. Allowed a different depreciation schedule that is shorter. A lot of them are shorter, thereby allowing you to get the deduction sooner rather than waiting the full 39 years to get a a most of, and all of the depreciation benefits.
And then again, when you pair that up, the five year and the seven year and the 15 year categories, let's say the, that, that wiring or that. Um, cabinetry. When you pair that up with a bonus depreciation, then you can essentially move a good chunk of it in one year. So essentially there is a one year asset class.
It's the five, seven, and 15 when you elect a bonus depreciation to take it all in the first year. And that is a very legal pathway to do that. Again. Why? Because the government wants to incentivize businesses to be willing to go drop cash, take out loans, and buy new things. Okay? Pros and cons of cost segregation, and I'm gonna stick to landing here with this episode on this segment.
Next episode, I'll get into. More granular details on cost segregation. Alright, what are the pros? Number one, you get front loaded depreciation that creates paper losses. We, CPAs and financial advisors love paper losses because you don't come out of pocket cash and yet you get a tax deduction for it. And sometimes you need that because the opposite is true for virtually every dentist.
Which is you come out of pocket cash and don't get the tax deduction. Now, I know what you're asking in your head, Wes, when am I having to pay a vendor or come out of Pocket Cash and I don't get a tax deduction in my business? Well, classic example, you take on debt, you pay back the lender, bank of America, provide Huntington, Wells Fargo, US Bank, PNC, you pay 'em back.
And guess what? The principle portion. Is not tax deductible. The interest is, but not the principle. And generally speaking, most of what you're paying back ends up being principle and you don't get a tax deduction for that. And that can be very painful. And you're gonna say, well, why not, Wes? Well, the reason why is because when the bank gave you that money to buy whatever you bought with it, you do not have to recognize that money from the bank as income taxable income.
Therefore when you pay it back, you don't, don't get a tax deduction. There's always a, a mirroring in the tax code around things like that. Okay, so let's go onto the second Pro paper losses offset rental income from your S Corporation's rent payment. So we'll get in the next episode. What is a reasonable rent payment that you can pay?
Because as the landlord and the tenant at the same time, you get to dictate what that rent is. And so a little bit, it's like your W2 to yourself from your own corporation. It should not be a function of a market, uh, rate paid to an associate for the amount of production you do. No. Your W2 to yourself as a dental practice owner is purely a function of tax and financial planning.
A hundred percent. 100%. Well, the same thing. When you own your building and you're the tenant, your rent should be a function of tax and financial planning. Within limits, just like the W2 within limits, the IRS has certain reasonableness requirements around what your W2 should be, and the IS is gonna have certain reasonableness requirements around what your rent should be to your LLC owning your building.
Alright, the third benefit, you build real wealth. You have this appreciating asset known as your building, a real estate asset and a tax benefit simultaneously. The next one, lookback studies available. If you've owned your building for years and you didn't do it. You may or may not benefit from going back and doing it retroactively.
Now, I'm gonna be very careful here because I don't want everyone who's owned a building for 20 years to say, I wanna go back to day one and do a cost analysis and redo everything. You don't wanna go and amend 20 year returns. Now there's ways to do this, uh, perhaps without doing 20 years of tax amendments in order to get the benefit of that.
However, and if you did that. And you suddenly got these massive tax refunds, you're probably gonna get audited by the IRS. So be careful here. Consult your CPA on whether or not you should try to go back in time and redo this. Alright, lastly, estate planning now. Right now with estate planning. The reason why people do estate planning is because they want their assets when they die, to go to their beneficiaries that they want it to go to and to pay as little as as taxes as possible.
That's the general concept of estate planning. And also if you become incapacitated, uh, then your estate planning will dictate what happens if you're not capable of making financial decisions on your own. That's estate planning in a nutshell. And the reason why it applies here is because if you own your building, when you pass away, it becomes a part of your estate and how that gets distributed or passed down to your beneficiaries or your spouse, and the tax consequences matter, especially because buildings can be worth quite a bit of money over time.
Now, right now it's not as relevant because the estate tax guidelines allow you to pass away with around what are we at? Uh, 11, 12, 13 million and you don't have to pay any taxes. And if you're on, on the death tax or the value of your estate, which is all your assets when you die, if it's under that 13 million, you don't have to pay any estate taxes anyways.
And if you're married, then you have that times two essentially. 'cause your spouse will get a hundred percent of your assets and not pay any estate taxes on that. As your survivor. Uh, and then when your spouse passes away, then it would go to your kids or whomever you want to, and you get to use both the, uh, of the spouse's, what's called lifetime exclusion of, right?
I think it's right around 12 million or so, and that's 20, you know, 22 to 24 million. That's a lot. Most dentists don't pass away with that much in their net worth. However, this changes a lot. Earlier in my career, it got all the way down to a million um, dollars. And so a lot of people who died in that year were paying a lot of estate tax.
And then it's incrementally gone up over time. And now we're at a very high level, to be honest, at 24 million. It is 2324. This's gotta be one of the highest lifetimes exclusion, allowing the vast majority of Americans to die and not pay that death tax or that estate tax. But it could come down, that's my point here.
It could come back down to sub 5 million, which is where it was for a long time. And if it did, then a lot of dentists need to do more advanced estate planning to avoid paying death taxes. Unless you want to and you believe, um, having inherited money can actually hurt people's lives, which there's a lot of research showing that can be the case.
If people inherit money too young and then they don't work for their money, they take advantage of it and they use it, um, they use it poorly and oftentimes it leads to a less productive, fulfilling happy life. So anyways, that's more of a philosophical discussion around passing on assets. But in this case, one of the benefits of having your building held in an LLC is you can, when you pass away, uh, a death to avoid paying taxes, you can start to gift some of the LLC interest that owns your building, that LLC that owns your building.
You start to gift some of that to your kids' or beneficiaries little by little over time, um, through what's called the annual exclusion, which allows you to give some of your assets. Two kids or other beneficiaries and not eat into that death tax I told you about, uh, exclusion, that lifetime exclusion of 11 or 12 million per person.
So there's these ways that you can leak some of the, of your net worth to your kids over time without eating into any of that lifetime exclusion. And the LLC of your building allows you to do that. Okay? So those are some of the pros. Of the cost segregation. Let's look at some of the things to be cautious about.
The first thing is what's called depreciation recapture. When you sell your building, the IS will say, how much depreciation did you take on that building? And up to the amount of depreciation that you took on that building, you're gonna have to pay 25% taxes federally on that. And then depending on your state, you're gonna pay state taxes.
So that could get all the way up to 35, 30 7% for some states, and that recapture is very expensive. If you bought your building and you took no depreciation, meaning that you didn't take any tax deductions on the building, and then you go to sell it and you sold it for the same price. Guess what, you're not gonna pay any taxes 'cause you sold it for the same amount that you bought it for and you never took depreciation to reduce your taxable income.
But to the extent that you did take depreciation on your building and uh, therefore got tax benefits, you have to recover those benefits by paying taxes on it. So that's one of the problems, which means you might ask me the question, well, what is the benefit then Wes, of even doing depreciation and accelerating that depreciation through cost segregation.
Well, one of the benefits of doing that is the time value of money. A dollar in your pocket today is gonna be worth more than a dollar in your pocket in 15, 20, 25, 30 years. And so when you get that tax deduction today, you can take that tax benefit and go and put in the stock market or roll it into a new investment and get the, uh, the tax deferred growth benefit of that dollar saved today.
Also when you sell your building, you may be in a lower tax bracket and if you're in a lower tax bracket, 'cause you're re retired and your income is a lot less, then when you do recover the taxes on the sale of your building, it will be at a lower tax rate as well. That's a tax arbitrage. Now, you could avoid taxes altogether if you sell your building.
Let's say you sell it to the buyer of your practice, very common. Even if they don't buy it on day one, they might have what's called a first right of refusal to buy it later when they have equity in their practice to get a loan to buy the building. 'cause typically lenders require 20% down and they buy the the building.
And now you're sitting on, let's say, $2 million that you just sold. And you're gonna pay some tax, a lot of taxes on that. You might end up paying 500,000, 600,000 taxes on that. And you're saying, I don't wanna go give the IRS five or 600,000 on the sale of my building. Well, if you roll that into another building through what's called a 10 31 exchange, you could potentially avoid all or most of those taxes.
So I'm gonna talk about that a little bit later in a future episode here soon. However, there are many options you have to avoid on taxes, but just know and be cautious that if you do sell your building, you're gonna have to recapture that depreciation at pretty high tax brackets. Alright, other things to be cautious about.
What's, what's called the passive activity rules? And this is, um, most dentists. If there is a loss in their LLC that holds the building, cannot use that loss to offset their W2 and K one income from their business called active income. You can't take passive losses from the building LLC to reduce your active income from your dental practice unless you're what's called a real estate professional, which it's virtually impossible to be a full-time practice owner and a real estate professional.
However, if you have a spouse that could change things and be an enormous. On unbelievable tax benefit, and I'll discuss that in, in either the next episode or the one after that. So, losses can only offset income in the building, LLC. Any in or any losses that exceed, you know, go negative. So any deductions that exceed your income.
Pushing you negative in your building LLC, those get what's called suspended and passed forward into the future when you do have net gains. Alright? Another thing to be cautious about is the study must be done by a qualified firm. You don't want to DIY this or use low quality studies. So, and the disadvantage here is you're gonna pay money for that study.
It's usually gonna be somewhere around five to 15,000, maybe even a little bit more, depending on how big the building is, and the study is gonna need to be. If you buy a building that has five tenants, not just you, that's gonna be a bigger study and may cost a little bit more. But like many things. You have to look at the net benefit.
This is something I love you docs, but something sometimes you're bit mar you think on the margins, which is, ah, I don't want to pay money for that. No, that doesn't make sense. I'm not gonna come out of pocket. No, I don't want other people grifting off of me. You have to look at this and say, what is the net effect to you?
And if the net effect is, you're better off by paying that vendor for that service. Then you should absolutely do that. That's what's called an investment, not a cost, because you're gonna get a return on that, on that outlay of money. This is the same thing with like a 401k. A lot of times we'll do an analysis to say, Hey, doc, you could fund in your four oh K, 401k with your spouse.
You could fund a hundred thousand into that. Now it's gonna come with $20,000 that you have to pay to your team for that. And the doctor will say, no, I'm not gonna come out of pocket and pay my team 20,000. They're not gonna care about it. They only want money in their bank account now for spending.
They're um, they're not gonna be appreciative of it. They're never even gonna look at the balance. They're not gonna consider it a benefit. And, uh, and frankly, I pay my staff probably more than I, I should. And so I'm not going to, I'm not, I'm not gonna set up a 401k and I say, doc, this isn't about the staff.
This is about you. And if you can fund a hundred thousand to you and your spouse, yeah, you're gonna pay 20,000 more. So 120,000, but it's a hundred percent tax deductible, and your marginal tax bracket is 40%. Okay, you're gonna save somewhere around $45,000 to $50,000 on that. Yeah, you come out of pocket 20 grand, but now you got a hundred thousand that's going gonna grow tax deferred in your account for many years.
The benefits on that are staggering and you're gonna pay less in taxes this year. Net net doesn't matter that you paid your staff 20,000. You are way better off by doing this 401k. Yeah, you gotta pay $2,000 a year to a third party administrator. To administer testing on it, yada yada. You gotta look at the net net effect.
Same thing here with a cost segregation study. If you gotta go drop 15 grand to do the study, but this thing is gonna save you in the first five years, $250,000 in taxes, then it's obviously well worth it to do so. Alright everybody, that is the first segment here of cost segregation, what it is, 1 0 1.
What are the pros and cons and why you, if you own your building. And maybe are aspiring to own your building should consider a cost segregation analysis. Until next time, enjoy.
Wes knows what's best for dental practices. He's been doing this for a long time and he sees lots of practices. He can tell me how our practice is doing, and what we can do to increase our productivity. With past CPA's, there were no ideas. It was all coming from me, saying "I think I can do better, but I don't know how." I come in to meet with Wes and he says "You CAN do better, and I know how."
PracticeCFO is in hundreds of dental offices around the country. They know what numbers should look like. They know what percentages of payroll, rent and supplies should be, and they will hold you accountable to those numbers, which will really help you stick to your plan and your path of growth and savings. That is invaluable
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When I go home from work, I don't spend a whole lot of time stressing about what my books look like, or how much I owe in taxes. By using PracticeCFO, the burden of keeping track of a lot of the big financial numbers and metrics are taken off my plate.
PracticeCFO helped me develop a plan for the future. I have colleagues that work with other accountants that don't have a plan - they just look at the numbers of the practice and that's it. There's no plan for 10, 20 years from now. But with PracticeCFO, you get that. PracticeCFO makes you feel like you're they're only client.
(In reference to his practice sale) What could've been super stressful, wasn't! When picking John and Wes, it was from word of mouth recommendations and other people's experiences from the past that really did it for me. And it turns out that those recommendations were right on the line.
Wes knows the business side of dentistry. His comprehensive plan will organize your personal and professional finances so you can focus on taking care of patients. Massive ROI.
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