Think Cost Segregation Is Too Expensive? Here’s Why You’re Wrong

by | BiggerPockets.com

As someone in the cost segregation industry, I have heard my fair share of misconceptions about it. It’s a complicated tax strategy—I get it!

What’s unfortunate is that sometimes those misconceptions can deter folks away from cost segregation, even though it could make sense for them to use it.

My advice? Don’t leave money on the table!

Demystifying Cost Segregation

One of the biggest cost segregation misconceptions I have heard is, “The building’s basis is too low for a study.”

Now, some may say that cost segregation would make sense only for buildings over $1 million in basis; however, the good news is, that’s not true.

In fact, cost segregation studies can be done on buildings under $500,000 in basis. 

You get cost seg! And you get cost seg! Cost segregation for everyone! (Channeling my inner Oprah.)

As a real estate investor, there’s a good chance you own property under $500,000 in basis (after land has been carved out). You may think that a cost segregation study wouldn’t make economic sense—which is true!

However, the good news is there are “economical” solutions out there that are more cost-effective than a full-blown cost segregation study.

Woman with her back to the camera standing in autumn meadow with her arms spread widely as she enjoys the beauty of life and nature.

Related: Multifamily Investors: Here’s Why Cost Segregation is Your Friend

Cost Segregation for Lower-Cost Buildings

Here’s an example of a cost segregation study on a building under $500,000 in basis. This study, in particular, was done on a single family residence. The building was placed in service in 2016 with an original basis of $94,180.

Prior to cost segregation, this building accumulated $5,851 in depreciation deductions. Post-cost segregation, $9,128 of additional depreciation deductions were added, bringing the total accumulated depreciation to $14,979. Way better than not doing a cost segregation study, right?

Related: Why Real Estate Investors Need to Pay Attention to Cost Segregation

The Engineering Approach is the Best Approach

If you do end up choosing an economical solution to a full-blown study, it is important to note that choosing a solution that is “as close to the real thing” is imperative. Just because your property isn’t worth millions doesn’t mean you should skimp out on quality.

The trick here is to ensure that the solution you’re using utilizes an engineering approach. You’ll know that the solution you’re using utilizes this approach if the study accounts for all aspects of an item.

In other words, are you including the square footage of the carpet? The exact number of cabinets? It’s all about the details. I think you get the hint!

Conclusion

Contrary to popular belief, it is possible to mock a cost segregation study on a building under $500,000 in basis if you choose the right methodology and software.

Just remember, the key takeaway here is to ensure that whichever solution you choose is based off an engineer approach, as this will help ensure your study will be defensible in case of an audit.  

Do you have any further questions about this concept? 

Ask me in a comment below. 

About Author

Mary Hitchcock

Mary is a Marketing Manager for a cost segregation software solution, Titan Echo (www.titanecho.com), located in BiggerPockets' hometown - Denver, Colorado! Mary was first introduced to the world of real estate investing when starting at Titan Echo. In her spare time, Mary enjoys exploring the Denver food scene or cooking in the comfort of her kitchen.

9 Comments

    • Mary Hitchcock

      Hi Katie. You certainly can do it by hand. However, keep in mind it is a lot more time consuming and leaves more room for error versus using software. Also, the IRS highly encourages that those doing a cost segregation study have a background in engineering/construction.

  1. Michael Ketchen

    Hi Mary,

    We got a projection savings done on two 13 unit buildings we own. While the cost of the study was not that expensive ($7k) for both, my CPA reviewed it and determined that for us to recognize the actual dramatic savings on the study we would have to about 15X our passive income gains. If this was the case for us, how does this make sense for any investor who is under probably 200 or so doors minimum? For context our portfolio supports our full time living and we were able to expense enough to still show a small loss this year as full time real estate professionals. Thank you for any more insight as I am always open to learn and save!

    • Mary Hitchcock

      Hi Michael,

      The power of utilization (passive loss limits) is super important. We recommend that our clients do a benefit estimate prior to engaging in a project so that they better understand if cost segregation can or cannot help. As you know, everyone’s tax situation is different. If you want to talk more strategy let me know and I can connect you with my engineer.

  2. Daniel Dietz

    Micheal Ketchen,
    Can you clarify what you mean by
    “my CPA reviewed it and determined that for us to recognize the actual dramatic savings on the study we would have to about 15X our passive income gains”
    Thanks, Dan Dietz

  3. Daniel Dietz

    Mary,
    I realize you are not a tax expert, but do you know in general that if there are 3 partners in an LLC, all who fall under 100K income and qualify for the 25K passive write off exclusion, can we EACH ‘take a share’ of say a 60K loss that might come from a CS study?
    Thanks, Dan Dietz

    • Mary Hitchcock

      Look at it this way: If the LLC/partnership did a cost seg study on the property and produced $60,000 in additional depreciation deductions for 2018, those deductions would be additional expenses against the partnership’s income. If that ultimately shows that the partnership had a loss in 2018, that loss would pass through to the partners on each of their K1s.

      Now, each partner includes their K1 into their personal tax return. Each of them presumably has a different tax situation, so how they can benefit from the loss in calculating their own taxable income is directly related to what else is going on inside their tax return.

      Passive loss limits is a tricky analysis, which is why we always recommend running the cost seg benefit estimate and sharing it with your CPA. They can plug the benefit into their tax-prep software and quickly determine if you can use the accelerated depreciation to lower your tax liability. Each of your partners should do the same.

      Sorry, that’s not as direct of an answer as you would like, but I’d hate to over-simplify a complicated analysis. Hope that helps.

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here