How practical is a cost segregation study for an SFR?

Question

I am reading about cost segregation studies and trying to determine the cost benefit analysis of the various approaches for SFR properties.  Here is what I have that I am considering studying:

2019 purchase of 3/1 SFR 1200 sqft townhome for $102,000.  Finished basement, central air, mix of carpet and hardwood.

2020 Settlement in Jan for 3/1 SFR 1540 sqft townhome for $124,000.  Very nicely finished throughout incl basement w/central air.

I read there are 2 major approaches: fully engineered which looks expensive and something that approximates a DIY with a software package in which the user does the property inventory and allows the software to perform an estimation.  It looks like the IRS respects the fully engineered approach a lot more than the DIY estimated approach.  The estimated approach appears to be a lot cheaper and maybe more appropriate for these kinds of properties.  DIY software appears to be about $400 - $500 per property.

Is there a ballpark estimating approach that can be used to set expectations of value?  I am thinking of something like this:

$102,000 - Total property cost when purchased

$ 10,000 - Value of the land

$ 23,000 - Value of 15-year and less depreciation schedule components based on guess at 25% of remainder ($92,000).

-----------

$23,000 - SWAG at value of bonus depreciation if study is done.  This is totally not defensible, but might help determine if it is worth it.

Any recommendations on viability, approach, products/services?  What does an engineered study cost for properties like these?  The properties are in Delaware County, PA (southeastern PA, near Phila).

Thank you!

Yonah Weiss · Answer

@James Mc Ree you are correct on your assessment of the engineered vs. DIY approach, in terms of credibility in the eyes of the IRS. It is a risk that a lot of smaller investors are ready to take, because it's not shaking the boat too much.

For the fully engineering approach, which is not only recognized by the IRS, but the rules and criterion are clearly spelled out in the CS audit techniques guide. My rule of thumb is it usually doesn't make sense on properties purchased for under $500K.

Rich O'Neill · Answer

Hey @James Mc Ree!

I looked into this as well a few months back. Determined it wasn’t worth it for my stuff under $100k but can’t remember the exact thresholds. I want to say it was close to what @Yonah Weiss mentioned at $500k.

I hadn’t heard of the DIY software. Could you point me in the direction of the software you are looking at so that I can look into it?

One thing my accountant and I have been doing is taking items that “should be replaced after every tenant turnover” and expensing it. Carpets, paint, window coverings, etc. Our justification is that since we replace it with every tenant turnover they are costs of doing business not capital improvements. This is definitely very specific to our situation so I would talk to your accountant before doing something like this.

James Mc Ree · Answer

@Rich O'Neill I read through the Titan Echo site.  They have online software that helps you build your property component inventory, assign them to depreciation schedules and ultimately determine values.  They have a $400 service that appears to leverage prior projects. It looks like you pick a prior project like yours and it imports the values from that project as an approximation.  Their $500-per-project cost appears to allow you to do your own inventory.  The shortcoming appears to be there is no engineer involved which could leave a user exposed if the IRS challenges the validity of the study.  I haven't done anything more than read their site and request a quote though, so they may already have that figured out.

There are a few other sites out there that offer similar-looking software.  I just googled for residential cost segregation software and skimmed other sites.  A defensible study in the range of $400 - $500 seems like it should be a can't miss solution.

Have you found a ballpark % that a study should yield, such as 20% of building value?  It seems like it should be worthwhile if the study yields $15,000 - $20,000 bonus depreciation on a property valued at $100k - $125k, provided the taxpayer can actually use it.  I think I will run into that problem as some will be carried forward and I won't get as much of the "accelerated" depreciation.

I expense all my soft repairs as they are always at 15 years or less depreciation.  I had a small fire at a property that is giving me the opportunity to renovate the whole.  Nearly everything I am doing is bonus-eligible.  I need to lookup the schedule for quartz countertops.