Doing a 1031 Exchange on a Short Term Rental that is Cost Segregated

[Cameron Nordin]

I have a short term rental that I self manage and am considered a real estate professional based on material participation rules.  I did a cost segregation on the property 2 years ago and am now in the process of selling the home to purchase a long term rental.  Based on the expected sale price, I am not expecting a capital gains hit as the sale price is only $15k more than purchase price.  My question is:  Since there is such a small capital gains tax hit, is there still a benefit to 1031 exchange to transfer any of that depreciation with the sale so I don't get a big tax hit on this sale?  Or is cost segregation not transferable with the 1031 exchange?  Thanks of any advice.  

[Jon Taylor]

@Cameron Nordin

A cost segregation study accelerates depreciation by classifying certain building components as personal property or land improvements, allowing them to be depreciated over shorter recovery periods (e.g., 5, 7, or 15 years instead of 27.5 or 39 years).

By accelerating depreciation, cost segregation lowers your tax basis more quickly than standard straight-line depreciation. This means that when you sell the property, your adjusted tax basis is lower, which increases the capital gain you must recognize.

Additionally, any accelerated depreciation taken is subject to depreciation recapture at a higher tax rate (up to 25% for real estate assets) rather than being taxed as long-term capital gains.

So, while cost segregation provides significant upfront tax savings, it also increases your capital gains tax liability upon sale unless you use a 1031 exchange or other tax-deferral strategies.

You can find your current tax basis by reviewing your depreciation schedule (Form 4562) and prior years’ tax returns, specifically looking at your adjusted basis on Form 4797 (for sales of business property) or Schedule D (for capital gains and losses).

Your CPA should be consulted prior to making any decisions.