Cost Segregation FAQ

[Julio Gonzalez]

Cost segregation studies is an area in which many people have a lot of questions about. I thought it might be helpful to address some of the most frequently asked questions that I receive.

WHAT IS A COST SEGREGATION STUDY?

A cost segregation study is a strategic tax planning tool that separates the assets that have a shorter useful life and can be depreciated over 5, 7 and 15 years from the residential rental property or nonresidential real property that are depreciated over 27.5 and 39 years, respectively. By accelerating your depreciation schedules, you reduce your taxable income which in turn increases your operating cash flow. This also allows for property owners to more easily write-off assets that get damaged/destroyed as the value of these assets is determined as part of the study. You will receive a report as a result of the cost segregation study that supports the breakout between asset classes and new depreciation schedule in the event that you are audited by the IRS.

WHAT IS THE COST OF A COST SEGREGATION STUDY?

If you’ve considered a cost seg study in the past but they were too expensive, times have changed and the fees have gone down significantly. The cost of a cost segregation study varies but typically ranges between $10,000-$15,000. The quality of the reports you receive also varies. Many cost segregation study professionals will offer you a free quote on the cost of the cost seg study specific to your property as well as the potential tax savings.

HOW LONG DOES A COST SEGREGATION STUDY TAKE?

Each property is different, however a cost segregation study typically takes about 4-6 weeks to complete in order to ensure a quality cost segregation study.

HOW MUCH MONEY CAN A COST SEGREGATION STUDY SAVE ME?

Based upon the cost seg studies of my clients, a building will typically yield 25-30% of the total cost that can be segregated into personal property and land improvements.

HOW DO I CHOOSE A COST SEGREGATION STUDY PROFESSIONAL?

There are many cost segregation specialists to choose from, so it’s important to perform due diligence. Here are some important questions to ask when choosing a specialist.

• Does the firm have engineering licenses with the state authorities?
• How long has the firm been in business?
• What is their reputation with the IRS?
• Will they defend my report in an IRS audit?
• Do they include energy tax benefits within their study?
• Do they have insurance and property tax reduction reports in their study?
• Do they have the proper insurance and licenses?

WHEN IS A COST SEGREGATION STUDY NOT A GOOD OPTION?

If your property is losing money, it is not recommended to perform a cost seg study. It is recommended to own the property for at least two years in order to take full advantage of the cost segregation study. Not all commercial properties qualify for a study. Price valuation is an important factor on whether a study is necessary for the owner or not. The tax savings should be significant in comparison to the cost of the study.

CAN A COST SEGREGATION STUDY BE PERFORMED ON PROPERTY THAT I PURCHASED IN THE PAST?

Yes. Property owners can obtain a cost segregation look-back study on their current property to recalculate the depreciation for previous tax years based on their reclassified assets.

CAN I STILL DO A COST SEGREGATION STUDY IF MY CONDOMINIUM COMPLEX IS A SHORT-TERM VACATION RENTAL?

Yes. It’s important to note that short term rentals depreciate differently than long term rentals. Although a condominium is considered residential property, it's typically depreciated over 27.5 years. However, in the case of a short term rental, it would depreciate over 39 years depending on if 20% or more of the units in the entire building are considered transient (rented for 30 days or less).

What other questions do you have about cost segregation?

[Julio Gonzalez]

@Bruce Woodruff While it may seem like a simple concept, it's actually a very complex process that requires significant documentation as well as specific methodologies. If the proper reports and documentation are not completed, you run the risk of failing an IRS audit and the cost segregation not being honored. Here's a link to the IRS website noting specific items that are included in the cost segregation study report.

[Michael Ho]

Hello, 

What do you recommend that the property be owned for at least two years for full advantage? Does that apply if the property was generating near maximum rents day 1 or the depreciation is best applied towards a full tax year? Thanks

[Dan Hazen]

@Julio Gonzalez, is the "25-30% of the total cost that can be segregated" typically applicable to a condo also? or is the % typically less on a condo vs a SFR? I'm considering buying a condo on gulf coast as an STR and wonder if a cost seg + bonus depreciation is something that could make sense.

[Bruce Woodruff]

That's a lot of $$....can't a property owner just separate the assets themselves if they are savvy, good at math, understand taxes, etc....?

Sure you might miss a thing or two, but....?

[Julio Gonzalez]

@Dan Hazen Are you looking to purchase a single condo or the entire condominium complex?

[Julio Gonzalez]

@Bruce Woodruff While it may seem like a simple concept, it's actually a very complex process that requires significant documentation as well as specific methodologies. If the proper reports and documentation are not completed, you run the risk of failing an IRS audit and the cost segregation not being honored. Here's a link to the IRS website noting specific items that are included in the cost segregation study report.

[Bruce Woodruff]

@Julio Gonzalez (I didn't read the link)...Does the IRS actually require these segregation studies?

[Dan Hazen]

@Julio Gonzalez, the whole complex would be nice, but just a single condo to start ;) If the condo costs $750K and a cost seg segregates 25% that can be bonus depreciated, it could potentially be worth considering. I’m just assuming a single condo wouldn’t segregate out that much, as compared to an entire building or standalone home. 

[Cameron Braig]

Thanks for posting Julio. Just came across this and found it helpful and insightful. Thanks again. 

[Joe Splitrock]

Quote from @Julio Gonzalez:

@Bruce Woodruff While it may seem like a simple concept, it's actually a very complex process that requires significant documentation as well as specific methodologies. If the proper reports and documentation are not completed, you run the risk of failing an IRS audit and the cost segregation not being honored. Here's a link to the IRS website noting specific items that are included in the cost segregation study report.

 I have seen people in the BP forums claim to do their own studies. One said they hold Professional Engineer status, so felt confident they could defend their work. I think their study consisted of a spreadsheet with breakdown of items. I have also seen cost segregation firms on BP talk about doing cost segregation on $200K houses. I always thought that wouldn't be worth the effort, but they claim a simplified process that only costs $500. These are referred to as computer based studies. I think they just enter a few data points and the software estimates based on an algorithm. This is a far cry from $10,000 to $15,000. It begs the question, what is the right answer? Should people be doing cost segregation studies on $200K or even $500K houses? It seems common on vacation rentals, but if you have a place in the mountains or on the ocean, land value is probably as much as the structure. It seems people may be accelerating too much. Maybe there is no enforcement, so it doesn't matter. I am not arguing any side, just curious your thoughts.

[Julio Gonzalez]

@Dan Hazen, it'd be worth having the numbers run! A cost segregation company should be able to help you do this and see what value having one could bring to you. At the end of the day, they should help you save money!

[Adriana Welborn]

@Dan Hazen Did you find out more information about doing a cost segregation on a single condo? We are also looking at one, and I haven't been able to find much information on whether this can be done on a single condo. 

[Bonnie Griffin Kaake]

Quote from @Adriana Welborn:

@Dan Hazen Did you find out more information about doing a cost segregation on a single condo? We are also looking at one, and I haven't been able to find much information on whether this can be done on a single condo. 

Yes, a cost segregation study can be done on a single family home or condo or business condo as well. As long as the purchase price is $200K or above it may be viable. The only way to really be sure is to get an estimate. 

[Bonnie Griffin Kaake]

@Bruce Woodruff  and @Joe Splitrock  and @Dan Hazen   No, the IRS does not require them to be done. Nevertheless, it is to an investor's benefit to do a cost segregation study.  The American Institute of CPAs (AMICPA) recommends they be done. It makes the accounting function easier going forward. Just make sure it is a quality study as pointed out in the link Julio gave in a previous post. The IRS' recommended methodology is an engineering-based study and includes a site visit as well as good documentation. It also needs to be done by someone experienced and knowledgeable in the fields of engineering, construction and taxation. You can usually expect about 25% to 35% of the property's purchase price can be depreciated and accelerated. The result is about 6% to 10% of your purchase price in after-tax cash-flow, depending on your tax bracket. 

As for condos, usually, there is a lot less land and therefore the tax benefits are higher than they would be for a single family home at the same purchase price. 

The cost of doing a good engineering based cost segregation study  is usually insignificant when you consider the time value of money and the benefits received. Of course if you don't have taxes to pay or you are going to sell the property in 1-2 years, you are not going to benefit enough to do the study anyway. 

The bottom line is you will benefit  greatly if you leverage the extra cash-flow resulting from the study

.

[Dan Hazen]

@Adriana Welborn, yes, it can absolutely be done on a condo. I ended up buying a SFH rather than a condo, but I spoke to multiple cost seg companies and it can make sense to do a cost seg on a condo if you can bonus depreciate, create a loss, and then offset other income to reduce your taxes. It seemed reasonable that you could do a cost seg on a condo for $3k or less, so it will likely save more in taxes & be worth it. Most important thing though is to make sure you are in a situation to be able to use that loss to offset income.

[Julio Gonzalez]

Completely agree, Dan!

[Josh Lifton]

Hey all!

I just recently turned my Boston condo into a rental property. I lived there for 9 years as my primary residence and now have moved but am renting it. I know that bonus depreciation is slowly being phased out, so because I started the rental in 2022 I wanted to see if despite living there so long, doing a cost segregation study makes sense. I was wondering if anyone had a) any input on if this thought process made sense or by having already lived in the property as my primary residence for so long negates any benefit I would get and b) if anyone had a recommendation of a Boston area firm that could do the study? 

Thanks,

Josh 

[Julio Gonzalez]

@Josh Lifton There can be a lot of variables to consider in this situation such as purchase price, any improvements made, REPS status or if the property is an STR, etc. Have you spoken with your CPA to see if you are able to utilize the accelerated deprecation and bonus depreciation from the cost seg study? I'd also recommend getting cost segregation study quotes to analyze the costs/benefits associated with the study.

[Bonnie Griffin Kaake]

@Josh Lifton   There are several things to consider, as Julio Gonzalez mentioned above. Also, you will want to consider what you paid for the property and if it is enough to warrant a study. Then, you need to know that the year you turned it into a rental is the year your able to do a cost segregation study. Your best bet is to get a quality engineering-based study estimate before deciding if it is going to be of value based on your specific tax situation. One more thing, you need to get it done for your 2022 tax filing so you don't incur an extra charge for the IRS form 3115 to Change from Straight-line to expedited depreciation. 

[Josh Lifton]

Thanks so much everyone for the responses. This is helpful to figure out where to start as I am unsure yet if this will truly be something of value to help lower my tax liability to be worth it given it is just a single condo vs a whole apartment building. 

[Swathi Vangari]

I bought a Condo in WA in 2018 and have never done Cost Segregation Study for it. Its been renting out since the time we bought it. Am I still good to do Cost Segregation for this property to help me minimize my taxes?

Do you have any recommendations for DIY tools or companies that offer this service at a reasonable cost?

[Josh Lifton]

Hey Swathi! As you can see from above I am still trying to figure this out as well but as fair as DIY, I know some people who used this website for a DIY cost seg and seemed happy with it. They have audit protection you can purchase with it.

 https://form.diycostseg.com/

[Swathi Vangari]

Quote from @Josh Lifton:

Hey Swathi! As you can see from above I am still trying to figure this out as well but as fair as DIY, I know some people who used this website for a DIY cost seg and seemed happy with it. They have audit protection you can purchase with it.

 https://form.diycostseg.com/

Thanks Josh. Yes this was the one popped up when searched online. Good to know that People were happy in the past. I hope there would be some companies who does this at a reasonable cost. 

[Bonnie Griffin Kaake]

@Swathi Vangari and @Josh Lifton  There are companies out there that do true Engineering-based Cost Segregation Studies that will let you sleep at night. In addition, they are reasonably priced and will pass an audit with no extra cost to you. If you haven't done a study, you are likely leaving a considerable amount of money on the table that could be getting leveraged into another property. As the IRS is gearing up with additional auditors, the low hanging fruit are depreciation schedules. The cost of an audit and lost opportunity for extra cash-flow, will cost you much more than the IRSs preferred methodology for a cost seg study. 

[Todd Goedeke]

@Julio Gonzalez you are way off the mark for cost of cost segregation studies. The cost is as low as $1500 on residential STVRs not $10k+.

Also a study can take as little as a week.

[Julio Gonzalez]

@Todd Goedeke This is just an old article and the price was more specific to commercial properties. We usually see SFHs starting around $3,000. The 4-6 weeks is also specific to an engineered cost segregation study which takes a much deeper dive into your property.