Once again: cost segregation hype

[Michael Plaks]

I have written about over-selling of cost segregation before. I will indulge myself one more time. 

See, cost segregation is indeed wonderful when it works. The problem is: it does not always work. But when you see it marketed online, including here on Bigger Pockets, the  impression you get is that it is pure magic, easily available to all, like on Oprah shows.

Examples are poached from a very prominent tax firm specializing in real estate.

Example A.

Is this a true statement? Yes. But it is an incomplete statement. It is missing an, ahem, minor detail: most cost segregation losses are blocked by PAL (passive activity limitation) rules. You need to qualify for one of the two exceptions: either operate STRs (short-term rentals) or meet the REPS (real estate professional status) requirements. Many investors do not qualify for either.

Example B.

Again, kind of a true statement. Again, missing critical details. Such as this one: the tax savings are not permanent. They are temporary, as in a loan. You have to return these tax savings when you sell the property without a 1031 exchange. 

Another missing part: the savings are for one year only. After that, you are back to where you were, unless you buy another property and apply cost segregation to your new one.

I am all FOR cost segregation. I fully support it and recommends it to my clients. WHEN IT IS APPROPRIATE. Which is not always.

Here are some of my older posts on cost segregation:

https://www.biggerpockets.com/forums/51/topics/1075919-five-...
https://www.biggerpockets.com/forums/51/topics/831924-beware...
https://www.biggerpockets.com/forums/51/topics/1136752-expla...
https://www.biggerpockets.com/forums/51/topics/1191846-cauti...
https://www.biggerpockets.com/forums/51/topics/831924-beware...

[Henry Clark]

I would treat it as an interest free loan or to offset higher income for the year.  

As a loan I would ask myself what would I do with the money the next 5 years?  If I can do 1 or 2 more deals and double triple my money then any future depreciation recapture or higher taxes due to less deductions is well worth it.  

If I treat it as a one time tax reduction due to higher income from other sources I would look at my tax bracket savings if any.  Although you could go thru the expense to refile returns.  But again treat it as a loan.  

If I was going to do it just to reduce taxes, and not invest the tax savings in a high return investment then I wouldn’t do it.  

One time we did so we could keep scaling. Doing either 100% or 400% COC returns in 2 years. Another time we had a farm land sale gain we offset.

This does play into any future sale of those two properties.  As far as timing or not scaling at the moment.   Or rolling via 1031 or scaling and reinvesting into another property where we didn’t write off again.