Real Estate Underground

Building Wealth Without Feeding the Tax Monster with Jason Melillo

• Ed Mathews • Season 4 • Episode 171

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Ed Mathews:

Greetings and salutations, Real Estate Undergrounders. It is Ed Mathews with the Real Estate Underground. Thank you again for making us a part of your day.

Ed Mathews:

I just found out we have breached the top 10 in global multifamily podcasts, and that is not because of me, that's because of you. So thank you so much for listening, thank you for sharing our show and, again, if you're new to the show or if this is your first episode, welcome. And with that we're going to introduce our esteemed guest, Jason Melillo. Jason, thank you so much for joining us. Jason, you're the CEO of KBKG, thank you. And so for those folks who haven't discovered you, hopefully that means they don't have tax problems, but if you could just give us a little rundown on who you are and what you do for a living, sure.

Jason Melillo:

First of all, congratulations on making it to the top 10. Pretty cool feat, yeah, and I'm honored to be here today.

Ed Mathews:

Turns out, it's more than my mom listening, which is great.

Jason Melillo:

Sure, I can tell you a little bit about us. We're not a tax preparer. We don't prepare people's tax returns for them. We work with investors real estate investors and their CPAs to provide certain tax benefits that are typically not done by the CPAs.

Ed Mathews:

Essentially, we're a strategist on certain tax matters for real excellent, and so when I hear tax strategy, the first thing that pops into my mind is depreciation and bonus depreciation, but I know we're talking about a lot more than that.

Jason Melillo:

Yeah, I think talking about bonus depreciation and depreciation is very topical. Last month the one big beautiful bill was passed bringing 100% bonus depreciation back, which is fantastic value. It supercharges the benefits of what we do for taxpayers and investors. So I think that's a big sigh of relief for a lot of folks in the real estate industry that have been monitoring that very carefully to help bring that back. Folks like the Real Estate Roundtable, the American Institute of Certified Public Accountants, that worked hand in hand to influence that and make sure that we're glad to have it part of our arsenal again and it's really going to make a huge difference for the taxpayers.

Ed Mathews:

Indeed, regardless of where you fall on the political spectrum. I'm a huge fan of that part of the bill in particular, but opinions vary on everything else and we're not going there.

Jason Melillo:

I can tell you, as somebody who's worked with people on the far left and the far right, the one thing that they all have in common, the common ground, is they hate paying taxes. So that's the good news there. That's the one piece of common ground I've noticed about people with different political ideals.

Ed Mathews:

And let's talk about for those folks that aren't really attuned to what bonus depreciation is.

Jason Melillo:

Let's define it for the audience Sure Under the tax law, people who buy property or whether it's real property or personal property are allowed to take a systematic charge against their income to reduce that income for tax purposes. That systematic charge is called depreciation. And what bonus depreciation does, instead of using a life of five years or 15 years, or 27 and a half years or 39 years, depending on the classification that we're talking about for a portion of that property that qualifies as a shorter life. So if it falls in the 20 years or less category, we can apply bonus to it. 100% bonus means that we can deduct 100% of it in year one.

Jason Melillo:

So if we buy a property real property, let's say a building and a portion of that building is allocated to shorter lives, whether it's 5, 7, 15 years that allocation let's say it's a $10 million building or a $1 million building and we end up with 15% of it in short life.

Jason Melillo:

That means that for that $1 million building, $150,000 of it can be expensed in year one, in year one. So if you think about it, if you're a investor in real estate and you've got $150,000 of rental income from that property and you would normally be taxed on that rental income in year one, you're not paying any tax and you can take that money that you saved tax and you can use it to invest in another building, put it into some other type of investment, put it in your pocket, spend it, do whatever you want with it. And what we see a lot of real estate investors do is they pace themselves as they invest in real estate so that every couple of two or three years they're able to buy another building with the cash flow that they're saving from the benefit of the depreciation and that just creates more depreciation deductions, which then allows them more cash flow to reinvest in their business.

Ed Mathews:

Yeah, and that brings up a really important point, and that is that taxation policy elicits certain behavior, and let's talk about that. So, when the government puts something like this in place, what are they trying to get guys like you and me to do?

Jason Melillo:

They want us to invest, they want us to spend. This is how our economy expands. The more we invest in property, that stimulates the economy because we're buying things to put in our property If we're building, certainly in multifamily, for example, we have a housing shortage and have had for a number of years, so they want to entice investors and developers to spend money to build properties so that we can provide more housing for people, which then when we build those properties, we have to put dishwashers and washing machines and refrigerators and TV sets and carpet. All these things that will also stimulate the economy and by incentivizing us to get these tax benefits, it allows us to reinvest and that accelerates the economic growth.

Ed Mathews:

Yeah, here's the ugly reality, right? The 2008 crisis. Not only was it hard on homeowners and hard on real estate investors, it decimated the general contracting population, and so what's happened since that over the last 17 plus years, is that it wiped out, from what I've heard, as many as 50% of the general contractors who build, and so they haven't come back. They've gone off to do other things, and so one of the main reasons why we've fallen so far behind is aside from red tape and a whole bunch of other things is because there are not enough hands and feet swinging hammers and carrying lumber to keep the people that are requiring or need affordable housing or even non-affordable housing. Those people don't exist in this industry, and so everyone's scrambling.

Ed Mathews:

I live here in Connecticut and the governor and the legislature is moving heaven and earth to incent investors and developers to convert office buildings and to take on opportunity zone projects and a whole bunch of other things that are really incentivizing people investors like us to take down a dormant factory or a dormant office building and convert it into housing where hardworking families can live, and slowly but surely, we're whittling down Connecticut. Last count I heard was we were down about 30,000 units. That's the number everybody can agree on. I've heard it's as many as 50,000. And that's just little old Connecticut. You're in California, I believe.

Jason Melillo:

Yeah, I can't imagine what your number is. Just at the beginning of the year we had massive fires out here. We lost about 17,000 homes just from the fires. So if you think about what that does to the LA County area, which is a huge area, there's a lot of people here that are in construction but that's a lot to absorb. So where you're already short, then to lose that much in homes it magnifies dramatically the issue was Indeed, and so let's get back to bonus depreciation just for a moment.

Ed Mathews:

How do you figure out what the depreciation is? I know there's simple math behind that. I'm going to let you explain it.

Jason Melillo:

You're the expert. So within a building we do something called a cost segregation study. If you think about reverse engineering the cost of a building, if you had new construction, it's relatively easy because you can look at construction bills and things like that. But what do you do with a building that's 30 years old, that transfers through an escrow statement? How do you know how much you paid for those items that technically would qualify for faster depreciation, that 5, 7, and 15-year lives? And so that's what we do.

Jason Melillo:

We take an engineering approach and we look at all of the elements that qualify. So if you think in an apartment building it might be window treatments, a certain decorative lighting, all, of course, appliances, which dishwasher and washing machine and garbage disposal and things like that. But kitchen cabinetry, countertops and things like that can qualify, with certain floor coverings, wiring and things that service. These items also qualifies. And then you get outside the building. You've got the land, improvements on the outside, whether it's a pool or gates, and the irrigation systems and things like that. So these are the types of things that we would identify and then we put a cost to it so that we can then identify which items are in those shorter lives and would qualify for the bonus depreciation Right on.

Ed Mathews:

And so now I'm also curious about that process usually takes, about how long. For an average it's called a million dollar building, so a million dollars here is probably an eight to 12 unit.

Jason Melillo:

Yeah, so we can do a study in less than 30 days. It's just a matter of fitting it into our workflow. But especially this time of year, as we get to the secondary tax deadline, we're working very closely with many CPA firms and their clients to get things done before the 9-15 deadline for partnerships and business entities and then the 10-15 deadline for individual investors. We've had it come up where I've been called the last week saying I have somebody. It's the 10, 15 deadline. Can you get an engineer out there and get it done? And we've got it turned around in less than a week so we can do it when we need to. We obviously prefer to have lots of time to fit it in and not have to rush something through, but we're always willing to work for somebody or work with somebody to get it done.

Ed Mathews:

You can have speed, quality or price If you you can have speed, quality or price.

Ed Mathews:

You, too, You're picking a week out. It's not price you're getting a break on. I can assure you. That's right. And with regard to that, what are some of the other strategies that you see investors like me delving into? And bear in mind the buildings that I own? A lot of folks that listen on this show are probably owning properties in a half million to less than $5 million range, right, Sure, they're not the 250 unit buildings more modest. So at what point does it make sense to hire somebody like you to do a cost seg?

Jason Melillo:

evaluation. It's a great question. So the point that it makes sense is when you have taxable income from your real estate activity. Now if there's a little bit of complexity here, if you have somebody that meets the classification as a real estate professional, you can actually use depreciation deductions that put you in a loss position. You can take that loss and apply it against other ordinary income. You have a husband and wife. The wife is a doctor, the husband's the real estate professional. The husband's activity as a real estate professional creates a loss. That loss can be applied against the wife's income from being a doctor. So that's where the real estate professional comes into play.

Jason Melillo:

If someone is a passive real estate investor they don't meet the criteria for a real estate professional. Then you just have to be careful. If you create a loss, that loss just carries forward. Your expectation is okay. I created a $250,000 passive loss. I have to carry that to next year because I don't have enough income.

Jason Melillo:

So if you're generating $50,000 a year of income from your real estate activity, then you've got a loss that'll take you forward for five years without having to pay any tax, which is still a victory. But you just want to manage your expectations around. Maybe I only need to do a depreciation study on one property instead of both of my properties, because I can't use them both at the same time. In order to qualify for a real estate professional 750 hours in your real estate activity and more than 50% of your time. If you don't meet those criteria, then you're technically not a real estate professional. You have somebody with a portfolio of real estate, but they're also an attorney. They spend 2,000 hours a year in their business as an attorney and they spend 1,000 hours a year in their business as a real estate professional, but as a real estate owner they're technically not meeting that criteria because not more than 50% of their time.

Ed Mathews:

Right, they better be spending 4,000 hours Right.

Jason Melillo:

If you've seen some legal hourly rates for some of the attorneys, I would question. Maybe they are claiming to spend 4,000 hours, yeah.

Ed Mathews:

I have a very close friend who's an attorney and I remember years and years ago and talking about having to have 2,500 billable hours and I'm like, wait a minute, the math doesn't math, because that's 50 hours a week just billing and you had administration and all that. He's got 18 hour days. Oh, okay, glad I didn't go to law school. In terms of other strategies, opportunity zones has been one of the things that we've had guests on the show talking about as well. I'm curious about some of the other strategies that you see higher-end investors taking advantage of. That would apply to anybody.

Jason Melillo:

I like looking at real estate from cradle to grave. And if you start out earlier in your career and you're investing in real estate, maybe you're investing in a duplex or you get that small apartment complex or whatever it is that you're investing in and then you want to get something a little bit bigger, how do you do that without paying a bunch of tax? The 1031 exchange tax-free exchange for real estate investors allows you to defer any gain that you had on your real estate and investment. So you paid $500,000 for your first property. Now it's worth $750,000. We don't want to pay the tax on that $250,000 gain.

Jason Melillo:

So we do a tax-free exchange. We use an accommodator, somebody that does this for a living. They take our property proceeds on sale and they hold them until we find the new property we're going to invest in. They take those proceeds, put it into the new property. Now we have our carryover basis from the first property plus any increase in that basis that we can now depreciate using a cost seg study again if we want to take advantage of the bonus depreciation on that step up, which is just the increase in fair value above the original fair value of our relinquished property. Just keeping it simple and we can do that over and over again. So if we're a real estate investor for 40 years we've gone from that first $500,000 property and now maybe we're sitting on a $10 million asset because we've just been able to trade up and keep growing that asset and it may just be a single property. Maybe we've just been able to trade up and keep growing that asset and it may just be a single property. Maybe we've expanded to a portfolio of properties and along the way we've used the depreciation benefits that exist for us as a real estate investor to pay very little or no tax, which I've worked with many people that never pay tax as a real estate investor.

Jason Melillo:

And then when they die, there's something called a step-up in basis for their estate and so they get a step-up in basis in the fair value. So their tax basis for income tax purposes might have been very low. Maybe it's a million dollars on that $10 million asset. There would have been a $9 million gain. But when they die, they get a step up in their tax basis to the fair market value on death, which means that they now have $10 million to either depreciate or they can sell the estate, can sell that property for no gain. So they avoid tax on the $9 million gain. Plus, they didn't pay any income tax throughout their life because they 1031 exchanged throughout their life, because they 1031 exchanged throughout their life. So from cradle to grave, you could pay zero tax on real estate investments.

Ed Mathews:

And so I want to. We touched on it, but I want to drill into it so that everybody's crystal clear on this. Ed Matthews buys a million dollar building here in Connecticut. That property over the next five years increases to, let's say, $2 million. It's been a good five years, right, and now I have a million dollar gain. However, we did a cost seg and have been able to whittle that down, that income down by, say, 200 grand, right, and so that applies and basically zeros out the income in our year one. Now Jason comes along and says hey, I like your property, I'm going to buy it. I want to buy it for $2 million. Ed says, okay, that's fine. Now he's got a gain of $800,000, right, my math correct, and I don't want to pay taxes on that 800,000. So I'm going to turn around and buy a $3 million building. It's a like-kind exchange and I'm going to 1031, exchange my money into that property and not pay taxes on that gain, right?

Jason Melillo:

Yeah, you're close. The one difference is the depreciation deductions that you take. One difference is the depreciation deductions that you take. Those reduce the basis that you have in the property. So you went from a $1 million basis to an $800,000 basis. So your gain is $1.2 million, not $800,000. But if you had no other income to report along the way then you'd have that $200,000 loss carry forward to offset a portion of that gain.

Ed Mathews:

But here's the thing that you hit on and I want to drive home I'm paying $0 on that from a tax perspective, on that gain, whether it's a million or a million. Two, because I'm 1031 exchanging it into the larger kind property, because I'm 1031 exchanging it into the larger kind property. And then I'm going to rinse and repeat for the next 50 years until I die and my two daughters after the funeral, my estate attorney does his work, puts my estate to bed, there's a stepped up basis and now Katie and Maggie have let's call it $20 million in gains that they pay $0 on. And I had paid $0 on all along the way because I did what you just laid out.

Jason Melillo:

Yep, and so for them. They can either retain the properties on a go forward basis and now they have $20 million to depreciate or they can take that cash out and put it in some other type of either diversify it, put some back into real estate and put some into stocks and bonds, whatever the case may be.

Ed Mathews:

So there is a very simple note that is in some vault in some attorney's office in Hartford, Connecticut and it says two things. It says sell everything. So as soon as that, I literally wrote that because I love real estate but I don't know that my daughters and my wife like real estate and I would rather have them have the cash and do what they need to do with it rather than have to manage apartment buildings when that's not what they do. So, yeah, my instructions are very simple upon my death, hopefully 75 years from now, Right, All right In terms of the other things. So we've talked about the 1031. We've talked about depreciation and bonus. Depreciation Is opportunity zones still a thing.

Jason Melillo:

Yeah, Opportunity zones are still a thing. They were renewed and expanded slightly under the one big beautiful bill Allows for people to defer gains on assets. It allows for gains in replacement assets that are qualified opportunity zone properties to become federally tax-free on sale. If you are not doing the strategy that we just talked about and you're going to invest in a qualified opportunity zone property and then you want all the gains during that holding period to be tax-free upon sale, you can use that cash to pay for retirement. That's what you could do with that. So that's a good way.

Jason Melillo:

And then the other thing as far as the cradle to grave example I gave you go from managing property yourself or hiring a property manager and having the risks that go along with it to maybe getting to a point where you want to get into an institutional type investment where someone else is managing it for you. You can 1031 exchange out of your property into something called a Delaware statutory trust. You've probably talked to people on your show before about this and it's a more institutional way to take and defer the tax, still get the benefits of real estate but just not have to worry about the management and you lose a certain amount of control. It's not a perfect world. One thing I know about real estate investors is they like to have control over their assets, but it does work for some people. When you get to be in your eighties and you just enjoy life and cash a check once a month, maybe that's a good way to do it. So I like to just bring that up.

Ed Mathews:

Yeah, One of my friends had asked me a while ago when are you going to retire? I'm in my mid fifties and I was like never. At the very least, I'm going to do one deal a year, but in the back of my mind of like, I'm never managing that property, I'm going to be handing it to someone a lot younger and with a lot more hours on their hands to handle. Yeah, I'll do a deal or two a year, but it's going to be me writing a check and expecting one once a month or once a quarter, not swinging a hammer when I'm in my eighties. Yeah, there's only so much. At some point I'd like to walk a beach or hit a golf ball or see the world and all those other things. All right. So with that I'd love to get into our lightning round the final five.

Ed Mathews:

Let's talk about purpose. You've done very well and you've helped a lot of professionals get where they're looking to go. Nevertheless, you get out of bed on Monday morning. You charge right into the office. For me, that's purpose. What is that in your world? How do you define purpose?

Jason Melillo:

I think there's two things. One I like helping people. I think it's fun to help people achieve their dreams, and I also like growing something. So I'm an entrepreneur that happens to be a CPA and that for my whole life I have been interested in growing a business, and that's really what's attracted me to help people do what they do by doing what I do. So we win together and I think that's a great relationship.

Ed Mathews:

Yeah, it's the old Zig Ziglar Help enough people where they want to go and they'll eventually help you where you want to go, exactly Right. So I'm always interested in, especially with senior leaders, the mentors they've had along the way, and really I'm curious about the best advice you ever got and who gave it to you.

Jason Melillo:

I think the best advice I've gotten from multiple people. My first mentor was my dad. He was an entrepreneur as well. He always said be a good listener. If you're a great listener, people will tell you what they want and what they need, whether it's an employee, a client, the markets. If you're a good listener, you'll see where things are going and what people are looking for and find the gold. And so that's what I've always tried to do in my career is to be a great listener and learn from that.

Ed Mathews:

Two ears, one mouth, right Yep, and, as I'm sure, make half a dozen decisions a day, and every once in a while I'm talking like one out of a thousand you probably like to have back. I'm curious about a mistake that you've made along your career that you'd love to have back, and how did you handle it?

Jason Melillo:

I will say this that I make tons and tons of mistakes. I fail with purpose. That was something that I learned in my career. Early in my career, I was deathly afraid to make a mistake. One of my college professors I took this entrepreneurial program when I was in college and they said entrepreneurs like slam dunks. I was looking at things from that perspective. You always have to be right about everything that you're doing because you want it to be a slam dunk, and I learned that you have to take calculated risks, and when you take calculated risks and you're wrong, then you learn something from it, and the best way to learn is to learn from your own mistakes, and so I think the mistake I made was not doing that soon enough.

Ed Mathews:

So yeah, I used to work for a guy in my tech days and he had a sign in his office that said break stuff Right, and couldn't agree more. I fundamentally believe you learn way more from your mistakes than you do from your success. I'm also curious about how you take in information, how you sharpen the proverbial saw. What book are you paying? Or even a creator, an author, who are you paying attention to these days? What's that book on your physical or virtual?

Jason Melillo:

nightstand. Say Traction by Gino Wickman is one that we're an EOS firm. We've been living by it for the last couple of years. So that from a book. But I find that information is coming at us so quickly that by the time it gets to a book it's old. So I've trained my feed to send me articles and periodicals, and I spend most of my time reading those just to see what's happening, what emerging issues there are. I like to listen to podcasts. I'm a fan of the All In podcast. I think they talk about a lot of emerging issues, and so I find that's a good place for information as well, Couldn't?

Ed Mathews:

agree more. It's one of my favorites. I'm also really curious and this is the last question of the lightning round how do you define success in your life?

Jason Melillo:

I would say if I'm having fun with what I'm doing, then I'm successful. I don't think you get to a point in your life where you don't need to do something anymore, but if you want to keep doing it because you're enjoying it, then that's the reason. That's the best reason. I've always told people find something you're passionate about and good at, and you'll be super successful in life. So I'm still passionate about what I'm doing. What I define success by is that if I'm still excited about it, then I'm successful at it Absolutely.

Ed Mathews:

It certainly makes getting out of bed on Monday morning as well, right. You can't wait to get to work or to do whatever you're doing. So when you're not talking about saving real estate investors from the horrors of paying federal tax, what do you like to do for fun?

Jason Melillo:

I like to play golf. I like to travel. Tax what do you like to do for fun? I like to play golf, I like to travel. I have a ritual once a week where I sit outside in the afternoon and I smoke a cigar and just think so my three ways to unwind. I obviously don't get to do all of those enough, but when I get to do it I really enjoy it.

Ed Mathews:

Excellent, and so if people want to learn more about you or your firm, what's the best way to do that?

Jason Melillo:

So if they want to learn more about our firm, they can go to our website, kbkg. com. We have all kinds of resources there articles, tools. We have a software solution site. As a matter of fact, for your listeners, if they want to use one of our tools to help them do a cost segregation study for a smaller property, for example, they can get a discount by just using the promo code underground 2025. Awesome, thank you. If they want to find me, they can find me on LinkedIn Jason Melillo.

Ed Mathews:

All right, Jason. Thank you so much for your time today. I know you're very busy and I'm grateful that you were able to carve out some time on your schedule to speak with us. It's a lot of fun, thank you. Continued good fortune and keep hitting them long and straight.

Jason Melillo:

Okay, will do.

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