Cost Segregation: Anything to watch out for?

10 Replies

Hi All! We are about to pull the trigger on a cost segregation study on our commercial building. I feel like we have done our due diligence...

-Vetted a reputable firm. 

-We qualify for RE professional status and meet the 500-hour requirement.

-The estimates work with our 2020 tax picture and review with accountant.

But before I sign their contract I wanted to reach out to the community and see if you have any tips on things to watch out for in this process. Anyone have stories I may be able to learn from before we go for it?

Thanks! Torrey

You mentioned RE professional status.  This would only be relevant if you are using the paper loss to write-off "active" income, as opposed to passive.  Its my understanding the you need 750 hours to qualify as a real estate professional.  That just gets you in the game.  To use the paper losses to deduct active income, you then need to prove that you are "materially involved" in the day to day operation of the property.  Keeping "contemporaneous" logs will help with proving this should you get audited.  I've been told that if you show property management fees being paid out, that can be a red flag for the IRS to take a closer look as to whether you are materially involved.  

Is this your understanding?  Its a bit of a gray area in my opinion.  I'm dealing with a similar situation and want to stay above the fray. 

Thanks for the response Paul! You are right. Let me clarify...I am a real estate agent and my husband is a full-time property inspector. We each have met the 750-hour requirement for professional re status. Where the 500 hours comes in is your activity in the rental business...Material Participation. The purchase of this building was quite a lift and we logged many hours in the due diligence and getting it closed. (We also own another building that we can include if we check the correct box on the return!) Post acquisition, even with a hired property manager, we have logged excessive hours in lease negotiations, strategy meetings and analysis. After discussing with our advisors, and looking at our time logs, I am comfortable representing that we have met the requirements and will be able to use this method to deduct active income.

@Paul Shannon we've been told by multiple CPA's and tax professionals that one can't have a full-time W-2 job and be considered for RE professional status, no matter how many hours they log.

Originally posted by @Drew Sygit :

@Paul Shannon we've been told by multiple CPA's and tax professionals that one can't have a full-time W-2 job and be considered for RE professional status, no matter how many hours they log.

That is correct. But if one spouse qualifies for REPS they can both use the passive losses to offset ordinary income.

 

@Torrey Benson looks like you've done your research. One thing I can think of to look out for is the timing of completion. With tax season upon us, and if you are filing for 3/15 tax deadline, just make sure they can complete the study timely.

Another thing, make sure their contract stipulates something about audit defense/protection. (Preferably at no additional cost)

Oh, and if you want a competitive quote, from another reputable firm... 😉

Originally posted by @Yonah Weiss :
Originally posted by @Drew Sygit:

@Paul Shannon we've been told by multiple CPA's and tax professionals that one can't have a full-time W-2 job and be considered for RE professional status, no matter how many hours they log.

That is correct. But if one spouse qualifies for REPS they can both use the passive losses to offset ordinary income.

@Yonah Weiss. What if my W2 job is in real estate (as in I am working as a property manager for my brother's RE business. It is a multi-members LLC and I am one of the 5 members, but I own only 1%)? Can I still qualify for REPS or no?

 

@Courtney Duong you have a good question, and this is a bit of a complex topic. What you need to know is that there are two separate qualifications, 1) in order to qualify as REPS you must be participating in a real property trade or business. 2) You need 750 hours of "material participation" in rental properties. 

In your case, even though you work as a PM, you need  to own at least 5% of the company in order to qualify as ownership, and use those hours towards material participation. Without knowing any more details about your specific situation, and any properties that you may own, I can't really comment as to whether or not you can qualify.



Originally posted by @Yonah Weiss :

@Courtney Duong you have a good question, and this is a bit of a complex topic. What you need to know is that there are two separate qualifications, 1) in order to qualify as REPS you must be participating in a real property trade or business. 2) You need 750 hours of "material participation" in rental properties. 

In your case, even though you work as a PM, you need  to own at least 5% of the company in order to qualify as ownership, and use those hours towards material participation. Without knowing any more details about your specific situation, and any properties that you may own, I can't really comment as to whether or not you can qualify.

@Yonah Weiss. Thanks for the response. We own and self manage 1 retail strip (9 units) and 10 SFH as of now (and still buying) so I am busy all the time working on acquiring and managing those. So I qualify for #1 and #2 you mentioned above, but then not meeting the 5% ownership of the company.