Do I need a professional cost segregation for new construction

16 Replies

I recently finished construction on an 8 unit apartment building and it contains a mixture of 5, 15, & 27.5 year property. My question is, I have invoices for what those specific items cost so do I still have to have a professional cost segregation done to break them out of straight line depreciation. My current tax preparer, whom I'm looking to replace, had no idea. Thanks in advance for any insight 

IRS has briefly mentioned this issue in

Revenue Ruling 73-410, 1973-2 C.B. 53, Private Letter Ruling (PLR) 7941002 (June 25, 1979), Chief Counsel Advice Memorandum 199921045 (April 1, 1999).

All emphasize that the segregation of cost to determine the 1245 property is factually intensive and must be supported by corroborating evidence.

In addition, an underlying assumption is that the study is performed by “qualified individuals” and “professional firms” that are competent in design, construction, auditing, and estimating procedures relating to building construction.

Also, IRS has entire audit guide at: https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-table-of-contents

They will make sure this is done correctly so better to get professional.

May be @Yonah Weiss can answer better. 

@Jon Begley Excellent question.

@Ashish Acharya was right on in bring the sources from the Internal Revenue Code. 

Tax preparers technically can try to make the breakdown themselves; however, without proper training in the engineering minutia that the IRS requires, they will not be able to get you the maximum benefits. I have been faced with a scenario where the builder's accountant attempted to make the 5/15/27.5 year breakdown, and then our engineers got involved, we were able to pinpoint around 30-40% more tax benefits that the accountant overlooked.

You can PM me, and I would be happy to discuss with you further.

@Jon Begley

You'd be wise to continue this conversation with @Yonah Weiss . His company is top notch, his customer service is excellent, and he could potentially save you thousands of dollars. 

Originally posted by @Yonah Weiss :

@Jon Begley Excellent question.

@Ashish Acharya was right on in bring the sources from the Internal Revenue Code. 

Tax preparers technically can try to make the breakdown themselves; however, without proper training in the engineering minutia that the IRS requires, they will not be able to get you the maximum benefits. I have been faced with a scenario where the builder's accountant attempted to make the 5/15/27.5 year breakdown, and then our engineers got involved, we were able to pinpoint around 30-40% more tax benefits that the accountant overlooked.

You can PM me, and I would be happy to discuss with you further.

I know it's a fine line. I'm not an engineer or CPA, but I was both the owner and developer of this building and I handled the contractors and wrote the checks. I can say with certainty that the road and parking area cost $12,966. This will be more exact than an engineers estimation but on the other hand, I may not be "qualified" depending on how you interpreted the code @Ashish Acharya was able to provide.

Edit: I forgot to mention that this building is in a low cost of living area and would not likely benefit from the upfront cost of a professional segregation.

Originally posted by @Ashish Acharya :

IRS has briefly mentioned this issue in

Revenue Ruling 73-410, 1973-2 C.B. 53, Private Letter Ruling (PLR) 7941002 (June 25, 1979), Chief Counsel Advice Memorandum 199921045 (April 1, 1999).

All emphasize that the segregation of cost to determine the 1245 property is factually intensive and must be supported by corroborating evidence.

In addition, an underlying assumption is that the study is performed by “qualified individuals” and “professional firms” that are competent in design, construction, auditing, and estimating procedures relating to building construction.

Also, IRS has entire audit guide at: https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-table-of-contents

They will make sure this is done correctly so better to get professional.

May be @Yonah Weiss can answer better. 

Thank you for your response. It is clear to see from the audit guide that things aren't always as simple as they seem. 

Originally posted by @Jon Begley :
Originally posted by @Yonah Weiss:

@Jon Begley Excellent question.

@Ashish Acharya was right on in bring the sources from the Internal Revenue Code. 

Tax preparers technically can try to make the breakdown themselves; however, without proper training in the engineering minutia that the IRS requires, they will not be able to get you the maximum benefits. I have been faced with a scenario where the builder's accountant attempted to make the 5/15/27.5 year breakdown, and then our engineers got involved, we were able to pinpoint around 30-40% more tax benefits that the accountant overlooked.

You can PM me, and I would be happy to discuss with you further.

I know it's a fine line. I'm not an engineer or CPA, but I was both the owner and developer of this building and I handled the contractors and wrote the checks. I can say with certainty that the road and parking area cost $12,966. This will be more exact than an engineers estimation but on the other hand, I may not be "qualified" depending on how you interpreted the code @Ashish Acharya was able to provide.

Edit: I forgot to mention that this building is in a low cost of living area and would not likely benefit from the upfront cost of a professional segregation.

The engineer will actually use your construction budget, not estimate. But with their expertise, they will know every last detail to accelerate the depreciation. Most cost seg providers will be able to give an upfront estimate, to see what kind of tax benefits that you will be looking at. 

Just something to consider...

Pending tax bill is supposed to get rid of 1031 exchange on non real estate property.

So...1245 property. So if you do a cost seg now, everything segregated out may lead to huge boot if you ever try to 1031 down the road.

@Natalie Kolodij  please clarify. 

If you are proposing, as I have heard others do, that once you re-allocate 1245 with a cost seg study, you cannot do a 1031 'like-kind' exchange on the value of that 1245 for 1250 (real property). I think this is a misnomer.

In general, the definition of real property under section 1031 is determined by state law. In contrast, the definition of real and personal property (1250/1245) for tax-depreciation purposes is determined under federal law. State law tends to classify fixtures in a building as real property. Therefore, property such as wall coverings, carpeting, special purpose wiring or other installations affixed to the building can be considered real property under state law and like kind for section 1031 purposes, but personal property in cost segregation studies. Thus, real estate owners can benefit from both the gain deferral under section 1031 for real estate exchanges and the enhanced cost recovery deductions of the cost segregation study.

I agree that there is still a hurdle of depreciation recapture to get over, which may actually compare the 1245 property from property A to property B. But that is really a discussion into itself. Who's posting it?

@Dave Foster  

Maybe you can provide some insight on how the 1031 process is impacted by a cost segregation study. 

It was my understanding that if you reclassify items into 1245 that you can't exchange straight into 1250 in a 1031, but I may be misunderstanding that. 

Originally posted by @Natalie Kolodij :

@Dave Foster  

Maybe you can provide some insight on how the 1031 process is impacted by a cost segregation study. 

It was my understanding that if you reclassify items into 1245 that you can't exchange straight into 1250 in a 1031, but I may be misunderstanding that. 

Please refer to the following Chief Counsel Advice https://www.irs.gov/pub/irs-wd/1238027.pdf especially towards the end of page 4.

@Natalie Kolodij I would be interested to know where your understanding about the 1245 came from. 

@Dave Foster it would be great to hear from you on this one too.

There is a GREAT resource for this that I discovered when listening to a webinar.  Heidi Henderson with ETS was the contact.  I found her website and have included a link below.  This is EXACTLY what she does.

I tried to find a link to the webinar that I watched, but couldn't find it.  I did, however, find another video that she did where she goes over what cost seg is and what to consider when evaluating this approach.  I have included a link to her video and her website below.  I have no affiliation with Heidi, or ETS.  I just wanted to pass along the info.

https://www.youtube.com/watch?v=M8wAWRmdpZg

http://engineeredtaxservices.com/meet-our-team/

@Natalie Kolodij and @Yonah Weiss ,  There's so many question marks leading up to the new bill that it's hard to speculate how the two types of property, 1245 (personal) and 1250 (real) will interact.

Up to now there have been two general guiding principles

One has been that State law governs the definition of real estate for 1031 and federal law governs rules of depreciation.  And in most if not all states, things like fixtures appliances, floor coverings, etc etc are considered to be part of the real estate.  So it has been possible to 1031 exchange all of a property under 1250 including portions that have been segregated out for accelerated depreciation under 1245 because the state says it's still real estate.  

The other guiding principle is that in any 1031 there will be a mix of 1245 and 1250 property in every sale and purchase.  So In any event it was possible to still 1031 most if not all of the sale.  It could just get complicated as you can imagine trying to allocate the sales side and then the purchase side for all the various types of property.

The joker in the deck is the potential elimination of 1031 for personal property.  I'm waiting for someone smarter than me to make the call.  Will this mean that the segregation of property into 1245 eliminates it's use in a subsequent 1031 exchange?  Or will the state definition of real estate still hold and even property segregated as personal can still be 1031d.

Who knows at this point???

Originally posted by @Yonah Weiss :
Originally posted by @Jon Begley:
Originally posted by @Yonah Weiss:

@Jon Begley Excellent question.

@Ashish Acharya was right on in bring the sources from the Internal Revenue Code. 

Tax preparers technically can try to make the breakdown themselves; however, without proper training in the engineering minutia that the IRS requires, they will not be able to get you the maximum benefits. I have been faced with a scenario where the builder's accountant attempted to make the 5/15/27.5 year breakdown, and then our engineers got involved, we were able to pinpoint around 30-40% more tax benefits that the accountant overlooked.

You can PM me, and I would be happy to discuss with you further.

I know it's a fine line. I'm not an engineer or CPA, but I was both the owner and developer of this building and I handled the contractors and wrote the checks. I can say with certainty that the road and parking area cost $12,966. This will be more exact than an engineers estimation but on the other hand, I may not be "qualified" depending on how you interpreted the code @Ashish Acharya was able to provide.

Edit: I forgot to mention that this building is in a low cost of living area and would not likely benefit from the upfront cost of a professional segregation.

The engineer will actually use your construction budget, not estimate. But with their expertise, they will know every last detail to accelerate the depreciation. Most cost seg providers will be able to give an upfront estimate, to see what kind of tax benefits that you will be looking at. 

 Thank you for all of your help. I plan to look into the cost of a professional service.

Originally posted by @Natalie Kolodij :

Just something to consider...

Pending tax bill is supposed to get rid of 1031 exchange on non real estate property.

So...1245 property. So if you do a cost seg now, everything segregated out may lead to huge boot if you ever try to 1031 down the road.

 Thank you for that information. I will pay close attention to the bill before I make any decisions. 

@Dave Foster   @Natalie Kolodij   @Yonah Weiss

Not sure if allocation to 1245 is a concern, regardless of what the new law brings.

Bought a $100k property years back. Allocated $10k to 1245, and $90k to 1250. Ignore land for simplicity. Ignore depreciation for simplicity. Now I'm selling for $500k and want to defer the $400 gain. 

All I'm doing now is allocating $10k to 1245, based on the concept that it did not appreciate, and the remaining $490k to 1250. There is $0 capital gain on 1245, and the entire capital gain is on 1250 - which goes into 1031. In other words, 1245 is out of the picture either way.

(With depreciation factored in, I would allocate to 1245 the amount equal to adjusted basis, for zero gain/loss still)

This assumes no cost segregation on the new property, to avoid boot - at least to the level of carryover basis. Additional basis can still be segregated.

Any issue with this, colleagues?

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