All Forum Posts by: Paul Caputo

@Jason Powell Could you do it yourself? Yes, you could. Should you do it yourself? No, you shouldn't. When the IRS reviews a cost segregation study the first thing they look at is the qualifications of the individual who did the study. If that's you and you have no construction engineering experience or training in the tax code pertaining to depreciation they'll probably say you're not qualified. In that case they can throw it out without any further review. Here's the rub, it's quite possible that they won't review the study. They simply don't have the manpower or budget to review every cost segregation study. There are so many things the IRS has to do and making sure depreciation is correct is pretty low on their list. Furthermore they'll usually only go after something if it's worth it, so they're looking for the big fish not the little ones. 

If the cost is your main problem with hiring a firm you're not looking hard enough. Lots of firms have popped up that will do cost seg for $500-$1,000. There's usually a bit of a do-it-yourself aspect paired with some proprietary software on these types of studies. Not really a great way to do it since these usually rely heavily on statistical sampling and computer modeling which can be quite different from the actual reality of the property. There's also several engineering firms that have lowered their prices to be more competitive with these software firms. 

The main problem with doing it yourself is figuring out what qualifies for accelerated depreciation and what doesn't, and then figuring out the cost basis for each asset. There are hundreds if not thousands of individual assets in a building, and it's usually not cut and dry if something qualifies or not. There's a six part test used to determine if an asset qualifies, the cost books recommended by the IRS are huge, expensive books ($250-$800+ books or online copies usually around 1,000 pages or more) and then everything needs to be adjusted for the location and rectified with the total cost of the property. There's a reason for the high cost of having it done right by an engineer, it takes a lot of time and work (usually 30-250+ hours) and engineers don't work cheap. I've seen many experienced CPAs try to do cost seg (no offense to the many wonderful CPAs here!) and half the depreciation schedule is wrong. Out of tens of thousands of depreciation schedules we've reviewed we've never seen one that was 100% correct, even from big 4 accounting firms with cost segregation departments. It's unlikely you'd be able to do much better without relevant expertise. 

All that being said there's nothing stopping you from doing it yourself. The IRS doesn't have any set qualifications or licenses required to do cost seg, but they assume cost seg is only done by individuals with knowledge of construction, construction techniques, design, estimation procedures and the tax code i.e. construction engineers or architects trained in cost seg. They say a study done by a construction engineer is generally more reliable than a study done by someone with no engineering experience. You'll save a few thousand dollars and likely get many thousands of dollars in tax benefits. If the IRS decides to look a little closer you'll likely have to give back all those benefits and have penalties, fees and interest to deal with. But they're probably not gonna look closer. So it's a roll of the dice, you'll have to decide for yourself. It's not a good idea, but lots of people do it with no problems. 

@Lesley Resnick Interesting idea. I'm all for solar, but you're gonna have to run the numbers to see if it makes sense. If you're doing it to give the tenant some free electricity you'd have to bump up the rent to compensate. Selling it all back to the power company might be the best way to go since then you're getting some monthly income to offset the cost, but the question is how much? Different power companies have different rules and the laws governing it are different everywhere too. One guy I met back in Colorado, which is great for solar since it's sunny 300+ days per year, had a big solar system on his roof and it completely paid for his electricity plus he got a $200+ check from the power company every month. Mind you he had made the house super energy efficient with all LED lightbulbs, energy star everything and a bunch of other stuff which probably wasn't cheap to implement.

One thing I'd recommend anyone do before considering solar is to checkout Google's project sunroof. They've mapped a big chunk of the buildings in the US and have some good info on the feasibility of a solar installation. Some houses are great candidates, others not so much. My place for example is terrible for solar. There are a bunch of trees in the yard that shade parts of the roof, can't even install satellite TV because of the trees. Plus in Chicago there isn't much sunshine in the winter and only about 180 sunny days per year. Google's estimate for my roof is $100 in savings OVER 20 YEARS! I used to live in Florida so while I remember lots of sunny days, I also remember lots of rainy days. Figure out how much sun the property really gets and what the panels would really produce before letting a solar salesman tell you it'll wipe out the power bill.

As for the bonus depreciation I do know that the solar system (not just the panels but the supporting systems as well) would qualify for accelerated depreciation on a rental. You actually get to elect whether to do 100% bonus depreciation to write off the whole cost in year one, 50% bonus depreciation to do half the cost in year one and the other half over the regular 5 year accelerated 200% DB schedule or not do bonus and and do the whole thing on the 5 year accelerated schedule. What makes the most sense would depend on your tax situation, but most opt for the 100% bonus. Just a note bonus is not extra depreciation, it's just taking all or some of it in year one instead of spreading it out.

Depreciation has nothing to do with financing. You can pay cash or use 100% financing and the depreciation would be the same. As such there is no effect on the depreciation when you refinance. Recapture only occurs when you sell the property. If you do a 1031 exchange you'd defer recapture until selling the property without doing an exchange.

@Eamonn McElroy @Christopher Smith interesting. CA always has to make things more complicated don't they?

Why would you take section 179 on rental property assets when you could use 100% bonus depreciation and achieve the same thing? Use the 179 on the stuff that bonus depreciation doesn't apply to.

@Allen S. I'd agree with the rest of the chorus here and recommend you keep searching. With only having one property you have a lot of time to figure things out, but having solid advisors early on can be the difference between having 20 properties 5 years from now and having 3 properties 5 years from now. This particular CPA sounds very much like a jack-of-all and master-of-none which may work for some people but is terrible for real estate. 

Cost segregation is my area of expertise so I can say this CPA may have a rudimentary understanding, but obviously doesn't really get it. Many years ago the only way to get a cost segregation study done was to engage a large accounting firm that has an engineering department. Back then cost seg would be minimum $25,000, but was generally closer to $100,000 so it did only make sense with large commercial properties. A lot has changed over the past 15-20 years in the cost seg space. Perhaps the most important development was the publishing of the IRS Cost Segregation Audit Techniques Guide in 2004. That made it possible for smaller firms focusing on cost segregation to form which has lowered the cost significantly. Without the huge overhead costs of a large accounting firm, independent cost seg firms can get the same work done (often done better) at a fraction of the cost of the big accounting firms. 

So to be fair there was a time when this CPA was correct about the $25k cost seg (You can still find big accounting firms that will charge this) but today there are many cost seg firms that can get this done at a much lower cost. 

Since you're already at a taxable loss on the property cost seg doesn't really matter until you start showing some passive income. Nice thing is you can get passive income from other sources and use the losses from cost seg on this property in the future. As long as the rules stay the same you'll be able to do cost seg in the future and get the benefits when you can actually use them.

It's a bit shocking to hear a CPA who "has plenty of experience with real estate" claim 1031 exchanges are not good for her clients. Of course nothing is guaranteed when we're talking about future tax law, but claiming it's better to pay capital gains now at "this low rate" than taking advantage of time-value of money and deferring the tax possibly forever just doesn't make sense. If you can not pay taxes it's better than paying taxes basically all the time. Again, it sounds like this CPA just doesn't get it. 

A lot of the CPAs who chimed in here would be a good place to start in finding someone who actually specializes in real estate @Michael Plaks @Brandon Hall @Basit Siddiqi and several others on BP would be able to help you with this and probably point you in the direction of someone who specializes in agriculture. It's always better to have several experts that each handle one thing very well than one person who says they can handle everything but really can't, because no one can! 

@Michael Plaks thanks for the mention! @@Mark Andrews everyone above is correct, some of the $200k is in the land, some of it is in the building. It’d be advantageous to use the allocation method that puts as little as possible in the land and more in the building. Cool thing here is the IRS lets you use any reasonable method to allocate between land and building (they call the building the improvement) It’s going to depend on the specific situation what is going to be best for you. Most common thing to do is use the county tax assessment. Using the $200k property as an example the county assessed value might be $20k with $5k in the land and $15k in the building. You’d use that ratio from the assessed value to the purchase price ($5k land/$20k total = 25% land, $15k building/$20k total = 75% building) to get $50k land and $150k building. Now the tax assessments can vary widely, I’ve seen land value as low as 3% and as high as 65%! The next method is use an appraisal. Obviously the appraisal has to have an allocation between land and building. Most do, but I’ve seen a lot that don’t break that down. On the $200k property the appraisal might say $30k land and $170k building. This is probably the most accurate since the appraiser is spending a lot more time evaluating the property than the assessor’s “drive-by” valuation. The easiest way is if there’s an allocation on the settlement statement. As long as it’s two unrelated parties with dissimilar interests this is regarded as the strongest valuatIon. The last method is doing your own fair market value calculation. Look at comps that you can find their land value (vacant lots of the same size close by are great to figure land value) adjust for differences and figure it out. This is the least defensible method since you’re not a licensed appraiser, but if you have data to back it up it works. As Michael stated you can get more detailed with a cost segregation study to further breakdown the building value into the structural and necessary components that have 27.5 year depreciation schedule, land improvements have 15 year schedules and tangible personal property has a 5 (or 7) year schedule. On a property this size it’d probably only make sense if you’re in the top tax brackets to do it.

@Jim Macedon Depreciation is pretty complicated. The proper way to have it all done is a forensic engineered cost segregation study, but on a single small rental property the cost-benefit sometimes doesn't make sense. A study would give you the cost basis and proper depreciation schedule (5 year personal property, 15 year land improvements, 27.5 year real property, while other schedules exist I've never seen a rental with any 3 year or 10 year property those are more specialized) for each asset. 

For this simple example of the $100k building and the new $5k roof you'd have two assets, the building and the new roof. Both are 27.5 year, but the in service dates are different. Say you bought the rental in January 2017 and put on the new roof in January 2018, you'd only have 26.5 years left on the building when you start the 27.5 years for the roof. Make sense? So if you improve the property 25 years into owning it those new assets get a new schedule.

The problem with this is what about the cost of the old roof that you tore off? You're technically still depreciating the old roof since its cost is entangled with the whole building. Depreciating retired assets is technically tax fraud. There's right around zero chance you'd get in trouble for that since the IRS has much bigger fish to fry. 

And there's not really a chart of what qualifies for shorter depreciation, it's more like "assets used in distributive trades and professional services, not including section 1250 assets." are 5 year assets. There's a 6 part test used to determine if something is section 1245 or section 1250, so again it's a bit complicated.

@Account Closed I'd recommend talking to a CPA who is familiar with Form 3115 and foreign real estate as it appears yours may not be, or depending on the specifics of the property having a cost segregation study done. Some firms will include Form 3115 with the study. Amending the returns is not a recommended method of fixing the depreciation and you can only amend back 3 years. Amending will also increase your audit risk. 

Really the only and best way to get all the depreciation you missed is with Form 3115, no amended returns required. 

@Kon Zel Only change to 1031's is it's only for real property now and personal property is excluded. 

If a $1mm property is depreciated halfway down to $500k and then exchanged for a $2mm property the basis in the new property should be $1.5mm for the $500k carryover basis and the $1mm excess over the original property. 

Am I on base and anything to add @Dave Foster?