Cost Segregation Study

45 Replies

I got a call the other day from a cost segregation firm.  He estimates that I can use bonus depreciation to get effectively $900k of depreciation in the first year.  This is due to taking advantage of bonus depreciation in the first year.  This sounds aggressive to me given the fact that I bought my multifamily for $4.4 million.  Does this sound right?  Does anyone have experience with this?  If so, can you share how much you were able to accelerate in the first year?  Also, if you can share how much a study costed you, that would be very helpful.

Thanks,
Luke

@Luke Chung Well it's a different ballgame now with Tax Reform because the "new" (we actually had 100% bonus a few years back but then it reverted to 50%) 100% bonus can now be applied to used property (as long as it's new to you), e.g., 5, 7, 10 (rare), and 15-yr property in your multifamily (assuming it was purchased on or after 9/28/17 which based on this post it sounds like it was...congrats!).

Previously, bonus depreciation was not available for the majority of cost segs because at that time bonus could only be used on new (to anybody) property.

I've seen cost seg reports reclassing 20%, 30%, even more to 5, 7, 10, and 15-yr property, so I wouldn't call that estimate unreasonable at all.  @Yonah Weiss could probably chime in with more details.

@Luke Chung

There are a couple of things to factor.

A) What does the property currently show for tax purposes?(income or loss?)
If you are currently showing a loss for tax purposes - you have to see if the additional depreciation will benefit you.
If you are not a real estate professional(it seems like you quit your other career and in RE full time now so you may be) your losses above $25,000 may be suspended and carried forward.
If the property was acquired in 2017 you may be able to carry the loss back 2 years. However, the new tax law does not allow you to carry it back.

Other than that - Cost segs can be a great mechanism to decrease your tax liability

I have done it twice over the past few years on larger apartment buildings in the Dallas area. I don't think anyone has mentioned, but you need to make sure you are in the game for the long run. If you decide to sell the building and not do a 1031, you actually have to recapture the depreciation and are taxed at a higher percentage than if it had been straight-line depreciation the entire way. It does help significantly reduce the tax consequences from cash flow on a larger investment property.

Good luck.

@Luke Chung

Buying in December was likely the perfect time to buy a large complex like you did. It was right after the tax law changed allowing more items be eligible for bonus depreciation. It was also right before the expiration of the NOL Carrybacks.

Did you have considerable amounts of tax on your 2015 and 2016 tax return?(fed + state)

If you did - you may benefit from doing a NOL Carryback. 

A real estate professional is a distinct designation from the IRS and there are certain rules/thresholds to do before you can call yourself a real estate professional for IRS purposes.

You may want to factor in all of the above to see what the cost of cost seg will be and what your decreased tax liability will be for 2017 and what your refund will be from carrying back the NOL to 2016/2015.

@Rich Weese I understand.  I expect my income to be lower in the latter years so I am ok with that.  Also, even though my tax basis will be lower which means higher taxes for me when I sell, it would be treated as capital gains instead of ordinary income.  I got a lot of income to expense off the last couple of years.  What do you think?

There is not enough info in your situation for me to reply. Your strategy, length to own, attitude toward the tax consequences and benefit to fast forward the loss. Both times cost me about 7K for the study. 154 units and 128. I probably delayed 7 times that amount in taxes the first few years. I'm getting ready to write 1.3 million to the Irs. That just guts me.... 

I have a chapter in my Book called "The worst partner you'll ever have". I feel that way about the irs more than ever before....

@Rich Weese

That’s incredible. That’s a huge chunk going to IRS which stinks, but I’d take the trade off of being in a position where I had to pay such huge taxes! I guess you win some and lose some. As long as the outcome is income...

Originally posted by @Rich Weese :

I have done it twice over the past few years on larger apartment buildings in the Dallas area. I don't think anyone has mentioned, but you need to make sure you are in the game for the long run. If you decide to sell the building and not do a 1031, you actually have to recapture the depreciation and are taxed at a higher percentage than if it had been straight-line depreciation the entire way. It does help significantly reduce the tax consequences from cash flow on a larger investment property.

Good luck.

The depreciation recapture really is no fun, but that's the case when you sell any property, not only when having done cost segregation. Recapture tax is capped at 25%, so it would actually be LESS than the regular tax bracket for many investors. 

One last point to note, if you wait at least 3-4 years before you sell, then you can literally 'write-off' all of the 5 year property as fully depreciated and you will not pay recapture tax on that amount at all! One of the BIG 4 law firms, has an even more aggressive strategy which employs writing off 5-year property upon sale after only 2 years of ownership! 

@Luke Chung Congrats on your recent purchase, and good for your for using this awesome platform to bounce your thoughts off of!

@Logan Allec Thanks for the shout-out! I echo your words. The new boost for cost segregation with the 100% bonus depreciation is awesome. @Brandon Hall just spoke about that on the podcast which aired a couple of days ago, highly recommended. Here's the link:https://www.biggerpockets.com/renewsblog/biggerpockets-podcast-269-how-the-new-tax-code-affects-your-real-estate-investments-with-amanda-han-and-brandon-hall/

Luke Chung, back to your questions. 20% is a fairly standard amount to be reallocated to 5, and 15 year property and accelerated. So it sounds right. You may also elect to take 50% bonus depreciation which will give you around $450K in the first year (according to the estimate you received), or you can do the regular accelerated depreciation, which can still give you a large deduction in the first year. 

It is also important to note that there are at least three different ways to calculate the spread of the deductions over the first five years, which allows you to customize the accelerated depreciation deductions to custom fit your tax needs, and maximize your benefits.

However, if you do not take advantage of bonus depreciation upon the first year of filing tax returns, you will lose the opportunity. It is only for the first year. Feel free to PM me for an additional estimate.

I went through this on two buildings purchased in late 2017. After paying the cost seg guy, the CPAs and the tax attorney I can tell you (I'm in CA, your mileage will vary on that and everything else), on a 4.4MM purchase I would have taken a 594k total depreciation loss in 2017 due to the new bonus rules.

Matt

Our bigger one, 95 units, was $7500 and the smaller one, 14 units, was $4500. Purchased 10/3/17 and 10/12/17. That's just the cost segs. CPAs and tax attorneys extra.

@Luke Chung @Matt Hoyt Seems like a bit much for a 95 unit, unless there was a great deal of uniqueness to each unit, or massive amounts of landscaping and other 15-year property. Multi-family properties are usually the easiest for an qualified engineer to perform a cost segregation study on, because the units are generally identical. The engineer will usually go into a few of each type of 1,2,3,4 bedrooms, and apply the findings to the rest (again, unless there is uniqueness to each unit) So between a 14-unit and a 95-unit and 300-unit there should not be such a huge discrepancy in pricing...just saying.

@Yonah Weiss I agree completely it's not that hard to scale the report. And I'm not here to tell you this was a difficult one. But our building is pretty high dollar value and I have to have a reputable firm do it for this particular situation. So that's just cost of doing business for me this time around.

Matt

@Matt Hoyt were those forensic detailed engineered studies? Most people don't realize that all cost segs aren't done the same way. The IRS describes 6 different methodologies: detailed engineering from actual cost records, detailed engineering using cost estimation, survey or letter, residual estimation, sampling or modeling and rule of thumb. The detailed methods are the most accurate, most defensible and get the most benefit. The IRS doesn't require any particular method, they just require it to be correct which isn't so easy with the other 4 methods. 

It's important to make sure you're getting it done right and protected in case of an audit. 

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