The appraiser used the income approach for the appraisal, but in the expenses analysis made some unrealistic assumptions...such as 3000/mo in landlord paid utilities, 8% contingency reserve, 8% vacancy...the list goes on. 

Deborah Hill you could always see if the bank allows assumptions and you could assume the loan (assuming the interest rates and rest of the mortgage is under market value for the home so you’re still getting a good deal).

Using all the basic assumptions for that theoretical property:1% rule: $54k/yr in rent50% rule: $27k/yr net after costsfinance on $330k note: ~$19k/yrcash flow: $8k/yearSo instead of loosing $5k cash over the next 8 years, you could be making $64k with a better performing property, and still building equity in the new property.  

I would be VERY careful about how you proceed, especially as it pertains to the Buyer moving forward with the assumption that you have a deal. 

I can send the actual excel file through email if you want to see my calculations and assumptions.

What else would you as for before trying to figure it out on your own or draw up some assumptions?

I’m not in your area, but I have Close friends from your area...I’m going to go out on a limb, and the assumption that 700k isn’t worth too much in/around Fairfax.

(My assumption is your property is older, less square footage with a smaller lot).

IRS has briefly mentioned this issue inRevenue Ruling 73-410, 1973-2 C.B. 53, Private Letter Ruling (PLR) 7941002 (June 25, 1979), Chief Counsel Advice Memorandum 199921045 (April 1, 1999).All emphasize that the segregation of cost to determine the 1245 property is factually intensive and must be supported by corroborating evidence.In addition, an underlying assumption is that the study is performed by “qualified individuals” and “professional firms” that are competent in design, construction, auditing, and estimating procedures relating to building construction.Also, IRS has entire audit guide at: https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-table-of-contentsThey will make sure this is done correctly so better to get professional.May be @Yonah Weiss can answer better. 

Since it sounds like your just starting out (my assumption), I would not want any negative cashflow sitting out there.