May be best FAQ

A quality Cost Segregation Study evaluates all information, including available records, inspections, and interviews, and presents the findings in a clear, well-documented format.

Our process for conducting a detailed Cost Segregation includes a review of all cost detail for the property, including but not limited to the general contractor's application for payment, construction invoices, change orders, depreciation schedules, and appraisals.

What should I consider when selecting a Cost Segregation provider?

You should always read the bio and resume of the persons signing your Cost Segregation study.

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Will the company be available if I get audited by the IRS?

Any company can give you a Cost Segregation report with results that save you a lot of money; the real question is whether it will stand up to IRS scrutiny. The true value of the fee you pay is how easy (or painful) the audit process goes. Every Cost Segregation company will say they stand behind their work, but how can you really know what will happen when the IRS audits the report?

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Do you have tax experts that can help if my CPA has questions?

Yes, we have tax experts on staff with combined years of experience filing tax returns. This is important because there are so many unique fact patterns and situations that can have an impact on how the Cost Segregation deductions will flow through on your tax return.

A Cost Segregation engineer does not necessarily know enough about tax to truly understand how the Cost Segregation deductions will specifically impact you. Using a firm like ours with tax experts on staff will save you money if your CPA has any questions regarding your specific situation.

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How long will it take to complete the study?

A Cost Segregation study will typically take 45-60 days to complete depending on how quickly we receive the information we need.

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How much will a Cost Segregation study cost?

The fee for a Cost Segregation study will range depending on the building size, building type, number of tenants, and other physical characteristics. Typically fees can range from $5,000 to $15,000. We specialize in smaller buildings and our studies average $2,500.

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How is depreciation impacted under the Alternative Minimum Tax (AMT) system?

Generally, for improvements placed in service after 1998, personal property identified in a Cost Segregation Study will require depreciation to be calculated using a 150% declining balance method as opposed to the 200% declining balance method. Although the acceleration of depreciation is slower under the 150% declining balance, the benefits of a Cost Segregation Study are not impacted significantly since the recovery periods remain the same. For improvements placed in service before 1998, the calculations are more complex and benefits from a Cost Segregation Study are likely to be somewhat lower than originally anticipated.

I have just constructed a building and the general contractor’s invoice already breaks down the costs. Can’t my CPA conduct the Study?

In September of 2004, the IRS released the first iteration of the Cost Segregation Audit Techniques Guide, in an effort to make clear what they are looking for in a Study. Of the 13 essential elements, the very first item the IRS lists is “Preparation By An Individual With Expertise And Experience.” They further explain the following:

“The preparation of cost segregation studies requires knowledge of both the construction process and tax law involving property classifications for depreciation purposes.”

“… a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background. However, the possession of specific construction knowledge is not the only criterion. Experience in cost estimating and allocation, as well as knowledge of the applicable law, are other important criteria.”

“A quality study identifies the preparer and always references his/her credentials, experience, and expertise in the cost segregation area.”

The reason the IRS stresses experience and expertise as being so important is that they recognize that there are no set rules that you can use to determine if the property is eligible. For example, a light fixture in one room may qualify as 1245 property (property eligible for a shorter accelerated depreciable life) while the exact same light fixture in the very next room may not qualify because of various facts and circumstances on how and why it’s being used. This applies to every asset in the building, and the onus (to prove and substantiate that each asset qualifies) is on the taxpayer. This is done by understanding each asset’s characteristics and knowing the circumstances for which legal authority can support your position on each asset. Because this is both a time consuming and confusing task, it is the exact reason why all the major accounting firms in the country have specially trained non-CPA professionals performing these studies. Below are citations from the IRS on this issue.

“The determination of whether an asset is a structural component or tangible personal property is a facts-and-circumstances assessment, and as such, no bright line test exists.” CCA 199921045; 5/28/1999

“A plethora of legislative acts, court decisions, and Service rulings have produced complex and often conflicting guidance with respect to property qualifying” ATG; Section 1

“It cannot be overemphasized that the classification of assets is a factually intensive determination.” ATG; Section 2

Taxpayers or CPAs that attempt to perform a study are very likely to miss-classify assets resulting in lower tax benefits and/or much more exposure during an audit. Additionally, an engineer can provide significantly greater tax benefits by breaking down construction costs even further through an analysis of the blueprints, a thorough facility inspection, and the use of proprietary software and tools.

Finally, another area of difficulty for a non-qualified professional is the allocation of construction “soft costs”. These “soft costs” also known as “indirect costs” are intangible costs that are incident to the construction of a facility. Indirect costs must be allocated proportionately to the basis of the specific assets to which they relate. For instance, a cost for HVAC design work must be allocated on a pro-rata basis to very specific HVAC “hard costs” (tangible costs). Because of the intermixing of services from various vendors within a construction project, it’s extremely difficult to determine the appropriate allocation and then to correctly apply those calculations without a software program designed specifically for that purpose.

The IRS has been involved in reviewing these types of studies for various tax purposes since the 1950’s. They have concluded (and stated on record) that this type of analysis is simply too complex for a non-qualified professional to perform. Below are just some of the many additional citations where the IRS states that a study should be performed by a third party qualified professional.

“Therefore, it is proper for the taxpayer to use a third party cost analysis to allocate costs to a building's structural components” Private Letter Ruling 7941002, 6/25/1979

“The use of cost segregation studies must be specifically applied by the taxpayer” CCA 199921045; 5/28/1999

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What’s the benefit of addressing abandonment issues in a Cost Segregation Study?

By quantifying all property including “structural components” by suite, our analysis will allow for the identification of costs that can be written off for future tenant abandonments. For a fully improved property acquired after 1996 with no cost documentation on those improvements, it’s impossible to take advantage of these benefits without a Cost Segregation Study. Although this is beyond the scope of the normal Study, it is standard in our product and it can significantly increase total tax benefits by as much as three times!

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I did a 1031 exchange into my property. Will a Cost Segregation Study still save me money?

Nearly half of the Cost Segregation Studies conducted involve properties in a 1031 exchange. However, there are situations where a 1031 exchange will negate the benefits of a Cost Segregation Study. Our CPAs have an in-depth knowledge of how a study interacts with an exchange and will let you know how using both tax strategies will affect your cash flow.

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I plan on selling my property very soon. Does Cost Segregation make sense for me?

If you conduct a Study on a property you plan to sell in a taxable transaction, you may have to recapture your accelerated depreciation deductions. However, this depends on when the property was acquired and what the value of the accelerated depreciation property is upon disposition (i.e., you may be able to create a large deduction and only have a smaller amount of recapture). Better still, if you intend to enter into a like-kind exchange (a non-taxable transfer of your property for another property), you will not have depreciation recapture issues until you sell the replacement property. In this situation, a Cost Segregation Study could be extremely beneficial. In addition, conducting a Study in the year of an exchange could give you the opportunity to pull out some cash (taxable boot) without creating any tax liability. Our tax experts will work with you or your CPA to assess your specific situation and inform you of what your options are.

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How long do I need to hold on to the property for Cost Segregation to make sense?

If the intention is to sell for cash, we generally recommend Cost Segregation for clients that will hold a property for a minimum of 3-5 years. We can calculate the exact "break-even" point to determine the benefits of a Cost Segregation Study based on how long you plan on holding the property.

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I have several partners in this property. There's no way they will all agree to amend their returns to take advantage of the study. Is there another way?

Yes. An amended return is no longer necessary to fix depreciation in the prior year. The IRS has recently issued Revenue Ruling 2004-11, which allows a taxpayer to file a form 3115 Automatic Change in Accounting in lieu of an amended return. This allows the taxpayer to take any missed deductions in the current year. The same form is also used to fix depreciation on assets acquired as far back as 1987.

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Will a Cost Segregation Study increase my chances of getting audited?

Not if you are taking depreciation you are allowed to, as identified by the IRS. In fact, the IRS has:

• Issued revenue procedures specifically outlining how Cost Segregation can be used

• Identified appropriate asset class lives that can be taken

• Specified guidelines on how the accountant should file for an automatic change in accounting method to account for missed depreciation

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Why has my accountant not performed a Study already?

The IRS recognizes that a Study requires engineering expertise. While an accountant may have knowledge in taxation, an engineer is needed to interpret blueprints, assess construction methods, inspect the building, and estimate components. Additionally, since the same asset can qualify in one building and not in another, knowledge of numerous IRS rulings is needed to ensure assets are being depreciated correctly for a specific situation.

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How much can be saved?

Every building is different. Savings depend on many factors, including purchase price, building use, construction methods used, design, and year acquired.

An estimate of savings can easily be obtained. Ask for a proposal. Generally, the savings is roughly 25 to 35 times the cost of the Study.

A Study is generally beneficial if the property is not operating at a loss and is generally applicable unless the property is a non-profit organization.

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How does a taxpayer determine the "land vs. building" allocation?

If IRS were to audit, they typically would first look to an appraisal to see if land was valued. If nothing exists, then they would look towards the county property tax assessor's allocation.

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How does a Cost Segregation study affect AMT?

Depreciation deductions from a cost segregation study reduce Alternative Minimum Tax (AMT).

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How far back can a taxpayer go to prepare a 3115 change in accounting method?

There is no limit on how far back you can go to claim missed depreciation deductions. However, at some point, the benefits will not make sense any longer with the age of the building/improvements. Generally, anything acquired less than 15 years ago is a good candidate.

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Can I amend a return for cost segregation from last year?

Once an accounting method is established after filing two tax returns, you are required to file a 3115 to correct depreciation. If the property was acquired last year, you can amend last year's return to claim missed deductions.

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What if my property was placed in service in a prior year and then subsequent improvements were done on a different date? What if the property was placed in service in phases on different dates?

The software is not built to handle this situation because there are too many possibilities related to the scope of the subsequent improvements. However, the software can still be used to provide a reasonable estimate of each asset's tax breakdown (provided that the total aggregate depreciable tax basis for improvements is less than $600,000). We recommend only entering the tax basis for the original acquisition. When the report is complete, the allocation %'s of each tax category (5 year, 15 year, 27.5 year) from the analysis could be applied to the subsequent improvements costs. For example, consider a building represented by two assets on the original depreciation schedule with asset #1 for $400,000 and asset #2 for $100,000. Using the $400,000 basis in the software, let's say the cost segregation report identifies 5 year property of $60,000 (15% allocation of the total). For asset #2 ($100,000), you would apply the same 15% to get 5-year property of $15,000.After you import the software results into the 481(a) Adjustment Software, you can simply add a second original asset with a different placed in service date to represent the subsequent improvements. In the example above, you would create a second original asset (for the subsequent improvements of $100,000) with a sub-asset for 5-year property totaling $15,000 (15% allocation) and a sub-asset for real property of $85,000.

Additionally- anytime better information exists, such as construction invoices, the classification of subsequent improvements should be based on what was actually done to the building. For example, if you spend $5,000 on new carpet it can all be classified as 5-year property. If you remodel the restroom, it should all be classified as 27.5-year property.

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Can you take the 179 expense on 5 and 7-year property from a cost segregation report?

Generally, the personal property from a cost segregation report is eligible for the 179 expense. However, it may not be eligible for 179 expensing for residential properties owned by passive taxpayers.

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Can you do a 3115, for the current year return, after the tax return is filed and the extended deadline passed?

Once the extended due date has passed (9/15 or 10/15), you cannot file a 3115 for that tax year.

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Can you perform a cost segregation study and file a form 3115 to take the additional depreciation in the same year as the sale of that property?

Yes, but recapture rules will apply. Therefore it almost never makes sense to do this.

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Can you use cost segregation deductions to offset capital gain taxes from another property(short term rentals)?

Yes.

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When doing a cost seg on buildings already in service in a prior year, would this involve a "change in accounting method" and/or an amended return?

You always have the option to file an automatic change in accounting method via Form 3115. No amending of returns is needed. An amended return can be done, but only if the building was acquired in the last tax year.

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Why is Cost Segregation important to consider when someone dies and used for estate planning?

The key benefit of using cost segregation in the estate plan is after death the heirs get a "step up" to fair market value of the property and get to depreciate the same personal property over again. However, there is another opportunity that many CPAs overlook. We create permanent tax deductions from a cost segregation study when someone dies.

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When does an accounting method become established?

If you file two consecutive tax returns since the asset was placed in service, you have established an "accounting method" related to that asset.

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What is the deadline to file the Form 3115 after the tax return is filed and in the same year?

You can generally file an amended/ superseded return to file a Form 3115 within 6 months of the original due date (that generally means it must be done before 9/15 or 10/15).

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Can you perform a Cost Seg study on the residential home that I live in?

No. You are not allowed to depreciate residential property that is not used for business or income.

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Does a taxpayer have to recapture the benefits from a Cost Segregation study upon the sale of a property?

Yes, there are three tax rates that may apply. Personal property from a cost segregation study is recaptured at ordinary rates (up to 38%), 1250 property is recaptured at 25%, Capital Gains Rate is 15-20%.

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What is a 481(a) adjustment?

That is the tax code section that explains how to calculate the missed depreciation deductions. It is equal to the missed depreciation through the previous tax year (not through the current tax year).

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If a taxpayer acquires a property to completely renovate, is this a good candidate for a cost segregation study?

If there is "intent" to renovate any part of the structure, the value of those components may need to be further discounted. For these situations, it is recommended to add the basis of any and all subsequent improvements to the total basis used in the Residential Cost Segregator. The Cost Segregation report allocations can then be used on each asset on the depreciation schedule.

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Please list examples of personal property that is "re-classified" in a cost segregation study?

Decorative light fixtures, finished millwork/cabinetry, kitchen plumbing, and appliance hookups.

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What is a passive investor?

One that is invested in real estate, but that it is not that person's full-time business or source of income.

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If a passive investor is paying taxes on his other business, can he use the deductions from the cost segregation report to reduce his taxes on his other business?

 

No, he cannot use passive losses to offset non-passive income. However, if he has other real estate properties, those would be considered passive and he could use losses from one property to offset income from another.

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Does a cost segregation study impact the personal property reporting for Business Property taxes in states?

Maybe. Depending on the state, the definition of personal property may be vastly different. Consult your tax advisor or a local property tax expert.

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If I did a 1031 exchange into a new property, can I do a cost segregation study on the new or old property?

Generally, yes but you generally need to step up significantly to make that work. Please read the following article The Interaction Between Cost Segregation and Like-Kind Exchanges

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If a company currently has NOLs, is there any situation where they can benefit from CS?

A company can always increase their NOL's through the implementation of a CS study. Those NOL's carry forward. "Real Estate Professionals" can also carry NOLs backward.

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How often can a taxpayer file a form 3115 for the same asset?

You must wait 5 years to file another 3115 on the same asset for the same issue. Example, you can't reclassify an asset from a 39-year tax life to 15 and then the following year change it from a 15-year tax life to 5.

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How does the basis of the exchange property in a 1031 affect what is analyzed in a cost segregation report?

Cost Segregation separates the property in buckets, 1245 and 1250. The trade into property must be equal or greater in value for the assets in each bucket.

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When performing a Cost Segregation study on a new building that was exchanged into, can the 1245 and 1250 categories be of lower value than the building sold in the exchange?

No, the categories must always remain equal or increase. If there is not an equal basis or a step up in basis, it will trigger recapture tax or "boot". Trading up is the general rule of thumb.

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What criteria are used to determine if an asset is a 1245 property?

There is not one determining criteria that is used. Over the years, the courts have used several tests including: Is it necessary for the business? Is the property designed or constructed to remain permanently in place? Is the component necessary to operate the buildings? Additionally, is the property capable of being removed? Is it readily removable? How much damage will the property sustain upon its removal? Movability itself is not the controlling factor in deciding whether the property lacks permanence.

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What are the 9 Units of Property for a building under the current repairs regulations?

For buildings, the Unit of Property is the 9 building systems defined: HVAC Plumbing Electrical All escalators All elevators Fire protection and alarm systems Security systems Gas distribution systems Other structural components identified in published guidance

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Do countries tax the segregated personal property for personal business ad valorem tax?

Or is the whole building still counted as real property with one tax bill as real property? The definition of Real Property the county uses to determine property tax might not be the same as the IRS definition of 1250 Real Property, thus they may not be related or comparable.

 

If I own property in Mexico and Canada, can I do a cost segregation study on those properties?

It depends. Property held outside the US is subject to different depreciation rules that the Residential Cost Segregator does not currently support.

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Does cost segregation apply for non-profit organizations?

No. Cost Seg reduces taxes so if no tax is being paid, cost seg does not help.

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What is the Amerisouth Case and its impact?

Apartment cabinetry, plumbing, finish carpentry, stove hoods and electrical panels were ruled as not 1245 property, but the case is controversial due to Amerisouth selling the property and not following through on the lawsuit

 

DOES COST SEGREGATION HAVE TO BE DONE DURING THE FIRST YEAR OF PURCHASE?

Contrary to the belief, you can do cost segregation anytime during ownership. Although it is recommended to do cost segregation as soon as possible to reap maximum benefits, you can play “catch-up” with the depreciation you may have missed. It is important to note that, in order to do this you must file a Form 3115 (Change in Accounting Method).

 

ARE CPAS THE ONLY ONES WHO CAN COMPLETE A COST SEGREGATION STUDY?

While we partner with CPAs to provide cost segregation services to their clients, the IRS Cost Segregation Audit Techniques Guide says that a study completed by someone with construction and engineering knowledge is better than someone without. It is important that the preparer has experience in cost estimating, allocation and tax law.

WILL A COST SEGREGATION STUDY INCREASE MY AUDIT RISK?

Simply completing a cost segregation study will NOT increase your audit risk. However, if you are audited and your methodolgies and procedures are not well documented

CAN I DO COST SEGREGATION ON MY PROPERTY IF I AM PLANNING ON SELLING IT?

If you haven’t filed taxes and reported the sale, you can still conduct a cost segregation study.

IS COST SEGREGATION WORTH IT IF THE VALUE OF THE BUILDING IS TOO LOW?

This topic is quite misunderstood as many believe that cost segregation can only be done on buildings over $1 million in basis. In fact, cost segregation can be done on a building with a basis as low as $200,000. Sure the benefit may not be as large, but you’re leaving money on the table if you don’t take advantage. Just make sure with your CPA that you can utilize the benefit, as everyone’s tax situation is different!

WHAT KIND OF PROJECT QUALIFIES FOR ECHO LITE?

Our requirements for an Echo Lite project are as follows:

1. The property needs to have a depreciable basis of less than $500,000

2. There needs to be a land valuation split out from the building

3. There can’t be any renovation/improvement assets included with the study

DO YOU HAVE AN EXAMPLE REPORT I COULD LOOK AT?

Unfortunately we are unable to provide a redacted or blank deliverable for security reasons. We are more than happy to explain in detail what can be expected within our deliverables though.

WHAT IS INCLUDED IN YOUR DELIVERABLES?

For a full study, our deliverable will include a full itemized breakdown of quantities for all materials and items for the property. The deliverable will have the legal analysis breakdown for each item/material so you can see how each was reclassed. We will provide a summary and display the overall benefit and tax savings. We also provide a 3115 attachment with suggested inputs if a 3115 is applicable on the project.

On an Echo Lite, we provide a reclass percentage breakdown for 5, 7, and 15 year buckets. We also provide the benefit amount and tax savings, and a 3115 attachment if applicable.

AFTER I SUBSCRIBE, WHAT IS THE NEXT STEP?

Once subscribed to Echo, you will have access to the Learning Academy for informational purposes, and the software platform where you can set up your property or properties. Once the properties are set up, you can run a high level benefit estimate with no commitments. An engagement letter will be produced with the benefit estimate so if you decide to move forward with a study, you can engage on the project.

CAN A CPA PERFORM THE LEGAL ANALYSIS ON A FULL COST SEGREGATION STUDY?

If a CPA is comfortable or has experience performing the legal analysis for a cost segregation study, they can absolutely take on this piece of a project and we can scope the fee accordingly. We also offer Legal Analysis training to any CPA with interest. Set up a call with us and we can discuss what is included with the training session.

 

defense. Most cost segregation experts and even IRS officials believe this is base case law.