Ever Done Cost Segregation?

Question

Has anyone ever done a cost segregation without the use of a firm that charges a lot for it? I have a buddy that's doing it himself and providing an excel sheet to a legitimate accountant. Any pros and cons to this?

My motivation is a tax bill for 2018 that my accountant just told me I owe. About knocked me off my seat. My tax rate is above what depreciation recapture is, so I'm ok with whatever the end outcome is upon the property sale (aka I am aware I'm reducing cost basis more) Thanks!

Mike Dymski · Answer

$500K property cost is a rule of thumb that some of the more affordable firms use to scope cost/benefit of a study.  And most firms will run a free feasibility study to scope it for you.

Jason Powell · Answer

Thanks! I mentioned the "legitimate accountant" so it was clear my buddy wasn't just winging it lol

I've never heard of cost segregation without an engineering firm and big fees. My buildings are small (but expensive-ish area) so it never seemed to make sense.

Charles Kao · Answer

@Jason Powell

I'm going to leave this article here.  I'll be blunt.  If you don't use a qualified person its a

bad mistake.

https://www.bedfordteam.com/frequently-asked-questions/

Todd Powell · Answer

My question for this panel is this a widely accepted practice among investors, or a lower percentage of people who see this as a wise thing to do. I have always heard of investors wanting the 27 1/2 years to get the building depreciation.  Also, if this building gets traded up on a 1031 exchange does this hurt anything ?

In other words, is this a smart thing to do or not. Pros and Cons greatly appreciated !

Jason Powell · Answer

Thanks for all the great responses! I think I've established that I will not do it myself, and that I will at least attempt to get a free feasibility analysis to see if it'd be worth it. Sounds like I'm on the lower range of being worth it per @Mike Dymski rule of thumb (some properties, costs plus rehab cost, of 450-700k range).

Bill S. · Answer

@Jason Powell

Jason, good advice hear for the most part. Paul gives a great explanation and validation for engineered studies. And the "don't do it yourself, although you could" advise is sound. That will be residual at best, and not stand up to an audit.

Using an engineered firm, that breaks down all assets (straight-line and short life) offers significantly more benefits, ability for retirement/disposition, and protects you in the unlikely event of an audit.

Most forms offer a free Feasibility Analysis, so that you can determine the cost-benefit analysis. Our firm offers options and price points, all with audit defense, based on your particular circumstance and tax strategy needs. While $500K is a reasonable rule of thumb, an engineered study can be done as low as $300K property because of the details. There are also options for SFR (rental homes), which are usually +/-$100K.

Basit above is correct. Know your tax needs and strategy before engaging a study. And do your homework on who you hire. The "engineering-based" study proclaimed by many is just that -- 'based' on engineering -- not actually a "fully engineered and accounted" methodology. Good luck.

Basit Siddiqi · Answer

@Jason PowellSince you have an accountant - have you asked him what you can do to reduce your tax liability? Since he knows your complete tax profile; he is likely the best to give you advice on what to do.With that said - how does he know your tax bill for 2018 - is he doing your 2018 4th quarter estimates?Whether or not you want to get a cost-seg analysis done(especially if you are wanting to reduce your current year taxes) is to see whether or not a cost seg will actually reduce your taxes.Depending on your income levels and whether or not you have passive income; you may actually not get an immediate benefit.Regarding a cost seg done by a non-engineer/professional. The chance that the IRS will fight it(especially if it's a small adjustment) is small. However, you risk losing the case if it gets audited which can bite back as you would be charged with penalties and interest.

Paul Caputo · Answer

@Jason Powell Could you do it yourself? Yes, you could. Should you do it yourself? No, you shouldn't. When the IRS reviews a cost segregation study the first thing they look at is the qualifications of the individual who did the study. If that's you and you have no construction engineering experience or training in the tax code pertaining to depreciation they'll probably say you're not qualified. In that case they can throw it out without any further review. Here's the rub, it's quite possible that they won't review the study. They simply don't have the manpower or budget to review every cost segregation study. There are so many things the IRS has to do and making sure depreciation is correct is pretty low on their list. Furthermore they'll usually only go after something if it's worth it, so they're looking for the big fish not the little ones.

If the cost is your main problem with hiring a firm you're not looking hard enough. Lots of firms have popped up that will do cost seg for $500-$1,000. There's usually a bit of a do-it-yourself aspect paired with some proprietary software on these types of studies. Not really a great way to do it since these usually rely heavily on statistical sampling and computer modeling which can be quite different from the actual reality of the property. There's also several engineering firms that have lowered their prices to be more competitive with these software firms.

The main problem with doing it yourself is figuring out what qualifies for accelerated depreciation and what doesn't, and then figuring out the cost basis for each asset. There are hundreds if not thousands of individual assets in a building, and it's usually not cut and dry if something qualifies or not. There's a six part test used to determine if an asset qualifies, the cost books recommended by the IRS are huge, expensive books ($250-$800+ books or online copies usually around 1,000 pages or more) and then everything needs to be adjusted for the location and rectified with the total cost of the property. There's a reason for the high cost of having it done right by an engineer, it takes a lot of time and work (usually 30-250+ hours) and engineers don't work cheap. I've seen many experienced CPAs try to do cost seg (no offense to the many wonderful CPAs here!) and half the depreciation schedule is wrong. Out of tens of thousands of depreciation schedules we've reviewed we've never seen one that was 100% correct, even from big 4 accounting firms with cost segregation departments. It's unlikely you'd be able to do much better without relevant expertise.

All that being said there's nothing stopping you from doing it yourself. The IRS doesn't have any set qualifications or licenses required to do cost seg, but they assume cost seg is only done by individuals with knowledge of construction, construction techniques, design, estimation procedures and the tax code i.e. construction engineers or architects trained in cost seg. They say a study done by a construction engineer is generally more reliable than a study done by someone with no engineering experience. You'll save a few thousand dollars and likely get many thousands of dollars in tax benefits. If the IRS decides to look a little closer you'll likely have to give back all those benefits and have penalties, fees and interest to deal with. But they're probably not gonna look closer. So it's a roll of the dice, you'll have to decide for yourself. It's not a good idea, but lots of people do it with no problems.

Matt K. · Answer

Unless you have the experience/background to be efficient or the free time to put into this... you'd probably be better off hiring out. I should also add the assumption is that you've gotten enough quotes that you'd realize a benefit from hiring out....

Eamonn McElroy · Answer

@Jason Powell

"Has anyone ever done a cost segregation without the use of a firm that charges a lot for it? I have a buddy that's doing it himself and providing an excel sheet to a legitimate accountant. Any pros and cons to this?" [Emphasis Added]

As opposed to what other kind of accountant?  Partially kidding...

Pros and cons....pro he saves himself a few thousand dollars this year.  Con he potentially owes more than a few thousand dollars later down the road in additional tax, penalties, and interest.

Ever Done Cost Segregation?

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