Cost Segregation Study for Single Family Residence?

Technical topics regarding tax preparation.
#1
TrueTax  
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I don't have any direct experience with cost segregation studies, but wanted some opinions from those of you who are familiar with them on whether it would be worthwhile in order to maximize first year depreciation on a residential rental. My client purchased a previously-existing single family residence for use as residential rental property for about $500,000 during 2018. My client also had over $150,000 of passive income during 2018 because of a nonrecurring capital gain, so losses up to that amount from the new rental property would be currently deductible in 2018. Do any of you have a sense for how much a cost segregation study might free up in depreciation deductions on a single family residence and what to expect as far as the cost?
 

#2
JR1  
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Sending to a client in this biz....I'll post his response.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#3
novacpa  
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I've seen them for as low as $1,500 - but those are "generic" (general) - and many will not hold up under audit.
You need a specific engineering study (licensed engineer PE, must inspect the Property). Separate 1245 Property
from "structural components".
Make sure the cost-seg group has a track record with the Service.
 

#4
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novacpa wrote:I've seen them for as low as $1,500 - but those are "generic" (general) - and many will not hold up under audit.
You need a specific engineering study (licensed engineer PE, must inspect the Property). Separate 1245 Property
from "structural components".
Make sure the cost-seg group has a track record with the Service.


What makes you say they won't "hold up under audit"?

I've used the ones through kbkg.com. They step you through a questionnaire to identify certain dynamics of the home and provide a report based on that. Used to be $400. As far as I'm concerned, this is good money spent.
~Captcook
 

#5
Doug M  
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As a side note, the description in the OP makes me think there is a large cap gain in 2018 and you want to offset that gain with the rental loss?
 

#6
TrueTax  
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Thanks for your thoughts on this. Doug M, in answer to your question, the client also has substantial ordinary income in addition to the capital gain.
 

#7
JR1  
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My client came back with a bunch of stuff, summarized here:
attached is an estimate for this situation. 15% was deducted for land value for estimate purposes. If you'll look at page five, you'll see increased depreciation expense resulting from our study is conservatively estimated at an additional $91,658 over straight-line depreciation. You can plug in their tax bracket to see the reduction in taxes, 37% was the default bracket used for fed, of course this reduces state tax also. Without a study the 2018 depreciation expense would be $8,373. Study fee would be $2,950, which as a tax deduction equates to about $1,859.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#8
Frankly  
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JR1 wrote: you'll see increased depreciation expense resulting from our study is conservatively estimated at an additional $91,658 over straight-line depreciation.
Do these studies also point out that accelerated depreciation in later years is less than it would be under straight line? How much extra tax will be paid then? Over say 20 years owning a rental house, what is the tax savings for each year? What is the tax effect of selling, considering unrecaptured 1250 gain, etc. etc.? They always seem to focus on the savings in the first year or two, the future be damned.
 

#9
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Frankly wrote:They always seem to focus on the savings in the first year or two, the future be damned.


Unless your taxpayer is currently in very low brackets and will absolutely, definitely, without a doubt be in, comparably, very high brackets in the future, this dynamic isn't worth considering. No one can predict future income levels or tax brackets.
A tax deduction today is worth more than a tax deduction tomorrow.
That's why no one addresses this dynamic.
~Captcook
 

#10
Doug M  
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the client also has substantial ordinary income in addition to the capital gain.


The taxpayer needs a rental income to offset the loss from the property to utilize the big depreciation deduction. Granted, it carries forward, but if the taxpayer does not have another property generating gains, it goes nowhere.
 

#11
JR1  
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Oh, don't misunderstand, I'm just passing this along. I've always felt that this was a waste of money. You're getting the same exact write off over time!! Is it really worth that much in time value of money to spend thousands on a study?
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
For FB'ers: https://www.facebook.com/groups/BenRoberts/
 

#12
Doug M  
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I think the trap is §1031 down the road where you end up with a bunch of unintended income on the sale.
 

#13
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JR1 wrote:Is it really worth that much in time value of money to spend thousands on a study?


It can be. Not always, but it can.
~Captcook
 

#14
JR1  
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It likely is, here....as I look at that 90k depreciation now instead of later....for sure worth the 2k of after tax cost for the study.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
For FB'ers: https://www.facebook.com/groups/BenRoberts/
 

#15
Coddington  
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Section 1031 isn't as big an issue as it could be. Most of the big cost segregation firms are taking the position that all of the short-life property they cost segregate is real property for section 1031 purposes. The Service will, quite likely, disagree and I personally advocate a more nuanced approach.

Most cost segregation firms use a net present value in their estimate of benefits. The better ones show, though do not highlight, how the taxpayer ends up having smaller depreciation deductions years down the road. The better firms will usually address future recapture issues, though often only if the CPA brings it up. Most cost seg firms do not suggest a study unless the NPV or first year cash impact is some multiple of the study fee, usually 8x-10x.
-Brian

Director of Tax Accounting Methods & Credits
SourceAdvisors.com

Opinions my own.
 

#16
TrueTax  
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Thanks--this has been a very helpful discussion! It sounds like some firms will do this cost segregation study without a site visit, but what they produce probably may not be sufficient to justify the cost segregation before the IRS? JR1, I am not sure if your client would include a trip to Southern California in the quoted fee? Can anyone recommend a firm who could do a Cost Segregation Study site visit in Southern California?
 

#17
JR1  
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I bet he does. Let me find out....or I'll just pm you his contact info....
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
For FB'ers: https://www.facebook.com/groups/BenRoberts/
 


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