At what price point does a Cost segregation study become worth it?

Question

At what price point does a Cost segregation study become worth it? I have a property I am almost done with the remodel on and it will most likely appraise for 160k and have another that did for 140k. Would it be worth it for me to do one on both? Those properties are on the higher end of the scale for my area. Thanks!

Chris Seveney · Answer

@JonPaul Kessinger

I would say not only is price a factor, but time. If you do not plan on holding these properties for the long-term and then do a 1031 into something else, are you doing is reducing your cost basis today, to pay the taxes on it, in the very near future .

Greg Scott · Answer

Really, the answer needs to be broken down into two parts.

Part 1 - Are you able to use the additional depreciation? If you are not a Real Estate Professional, you might see little to no benefit to doing a cost segregation analysis. Talk with your CPA. Obviously, if it won't lower your taxes, no point in doing it.

Part 2 - What is risk / reward trade-off? This may sound like a strange question, but the IRS recognizes a number of ways to do a cost segregation analysis. This is from the IRS Cost Segregation Audit Technique Guide, publication 5653 https://www.irs.gov/pub/irs-pdf/p5653.pdf

Various approaches may be utilized in completing cost segregation, including:
1. Detailed Engineering Approach from Actual Cost Records
2. Detailed Engineering Cost Estimate Approach
3. Survey or Letter Approach
4. Residual Estimation Approach
5. Sampling or Modeling Approach
6. "Rule of Thumb" Approach

The most robust and most expensive is #1. On a large apartment complex, we'll typically spend about $8,000 to get one of these done. For a multi-million dollar asset, that is totally worth the cost, and will almost certainly pass an audit. The problem is those studies rarely make sense on a single family property.

There are companies out there that can provide a more affordable Cost Seg for you using one of the other methods (or combinations of methods). It may make financial sense, but there is more audit risk.

On the other hand, I have a friend that owned a dozen similar properties. He did a full engineering study on the first three, found they were all about the same, and then used #6 for the others, figuring the earlier studies justified the ballpark number he was using. His thinking was even if the IRS says I'm wrong, I won't be wrong by much. I'll pay the back taxes, if any, and move on.

Julio Gonzalez · Answer

@JonPaul Kessinger We've done cost segregation studies on homes with a purchase price as low as $150,000. Whether you're able to benefit from the study depends on a multitude of factors, many of which Sean listed. I'd recommend getting a cost/benefit analysis quote to be able to see if you'd benefit from a study. Many cost segregation firms offer this for free.

Sean O'Keefe · Answer

hmm there are some self-service cost seg options out there that are cheaper than $7-10k. I'm not saying they're better ...

Mark H. Porter · Answer

In my case, the studies cost between $7-10k and the thumbnail value is $2M.

Sean O'Keefe · Answer

@JonPaul Kessinger To do a cost seg. or not depends on a few factors including, but not limited to:

• What you are hoping to get out of it (e.g. offset other income in the portfolio, get a big refund to put down on another property)
• How long do you plan to hold the property (depreciation recapture of 25% might make this less worthwhile if you sell the property in 2 years)
• Did you already place the property in service and start depreciating it for 27.5 years (LTR) or 39 years (STR). In this case, it's messy to fix this and you have to file a Form 3115.
• You would consider a 1031 exchange to avoid depreciation recapture.
• Type of property (STR or LTR),
• How high is your W-2 income / other income
• REPS
• How high is your W-2 income
• More factors ….

I’d get support from a tax pro to help you model this out and understand tax impact of cost seg to help in the decision-making process.
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*This post does not create a CPA-client relationship. The information contained in this post is not to be relied upon. Readers are advised to seek professional advice.

At what price point does a Cost segregation study become worth it?

At what price point does a Cost segregation study become worth it?

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