Cost Segregation. Is it worth it?

Question

I'm trying to execute a 1031. Buying a 30 unit multi family in New England for approx. $5m. I"m carrying over assets I've owned and depreciated for 16-22 years (4 different properties). From my preliminary research I see I will only have partial depreciation due to the carry over on the new purchase.  Is it worthwhile to pay for the engineering for a cost segregation study for the new property?

Ashish Acharya · Answer

Robert, yes a cost segregation study can still be worth evaluating on the replacement property, but the 1031 carryover basis makes the analysis more nuanced than a normal $5M purchase.

In a 1031 exchange, your old adjusted basis generally carries into the replacement property, and any additional basis created by new money or additional consideration is treated separately as excess basis. For depreciation purposes, the carryover-basis portion generally continues under the prior depreciation framework, while the excess-basis portion is generally treated as newly placed-in-service property.

So I would not assume you can simply cost-seg the entire $5M purchase price as though everything were brand-new basis.

What I’d want modeled is:

• Your carryover basis from the four relinquished properties
• Depreciation already taken
• The amount of new/excess basis in the 30-unit acquisition,
• How much of that basis is attributable to land versus depreciable property,
• And whether accelerating additional depreciation actually creates a usable tax benefit for you.

There is also an election available under the depreciation rules that can change how the carryover and excess basis are handled for depreciation purposes, so this is one where I’d have the CPA and cost-seg engineer coordinate rather than ordering a study in isolation.

On a roughly $5M, 30-unit multifamily acquisition, I would absolutely run the cost-seg analysis. I just wouldn’t judge whether it’s worthwhile based on purchase price alone.

Happy to connect and share some of our resources that might be helpful!

Stanley Odum · Answer

Michael, in no way, shape, or form do I want to distort the truth to promote our services. If I have done so, please cite your sources so I can correct my mistakes and give you full credit. I don't agree with "...and a responsible estimate in such situations cannot be done by cost seg providers, only by accountants." Better version:  "...should not be done by cost seg providers alone but with the guidance of a licensed tax practitioner." Note that I greatly appreciate and respect most of your opinions and posts on this forum, regardless of your obvious disdain for cost segregation providers who disagree with you and call you to the table if/when necessary. To all the folks reading this, I apologize for boring you with our sparring. "Iron sharpens iron, and one man sharpens another (Proverbs 27:17 ESV)."

Michael Plaks · Answer

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Stanley Odum · Answer

@Michael Plaks Re: "Any other answer, including free estimates by cost segregation companies, will be nothing but a GUESS." This is your opinion, not a fact. Most reputable cost segregation firms work with prospective clients and their tax professionals to determine (calculate) the carryover and new (excess) basis upfront. It is NOT guesswork and is a critical step in providing an accurate preliminary analysis (estimate) and final result.

Stanley Odum · Answer

OK, let's try this again so you and the other readers of this post will hopefully understand. Most reputable cost segregation firms work directly with the client and the client's tax professional to calculate the carryover and new (excess) basis prior to providing an estimate for a cost segregation study. Again, there is no guesswork when it comes to these basis calculations because we MUST determine upfront whether or not it makes sense to provide the estimate.

Aaron Weikle · Answer

The 1031 carryover complicates the math but doesn't kill the case for cost segregation. It actually makes the analysis more interesting. What’s actually happening is your basis in the replacement property is reduced by the deferred gain from the relinquished properties. So yes, you're starting with a lower depreciable basis than a straight purchase. But cost segregation doesn't care about the total basis so much as ‘how’ that basis is allocated. A study reclassifies portions of the building from 39 year (commercial) or 27.5 year (residential) straight-line into 5, 7, and 15 year MACRS property. This includes land improvements, fixtures, certain electrical and plumbing components of course. On a 5 million acquisition and even after basis reduction, you might have 3.2 to 3.8 million of depreciable basis. Reclassifying 20–30% of that into short-life assets is a real number. Bonus depreciation is the other piece. At current rates (60% for 2024 assets placed in service), any 5 and 15 year property identified by the study gets a big first year deduction rather than being spread over 27.5 years. That accelerates cash value even when your total depreciable basis is compressed. The study itself on a 30 unit multifamily typically runs $5,000–$10,000. If you're in the 37% bracket and the study identifies $400K in reclassifiable assets, the first year tax benefit can hit $90K or more depending on bonus rates and your passive activity situation. The ROI clears easily on those numbers. Where it gets complicated is passive loss rules, your AGI, and whether you qualify as a real estate professional matter a lot here. Run the numbers with your CPA before commissioning the study, definitely not after.

Jason Malabute · Answer

The piece that trips people up on an exchange like this is that the $5M price tag isn't the number a study actually gets to work with. The basis you carried over from those four properties keeps running on its old depreciation schedule, and only the additional basis you're bringing into the 30-unit gets treated as newly placed in service, so somebody has to compute both pieces before anyone can quote you a benefit. There's also an election that changes how those two buckets are handled for depreciation purposes, which is why the study firm and whoever prepares your return should be talking to each other instead of working in isolation. On a deal this size it's usually worth running the numbers, but I'd be skeptical of any free estimate that never asked what your carryover basis and prior depreciation look like, and I'd want the analysis to include whether accelerated deductions would even be usable on your return this year. It all depends on your specific facts, so work through it with your own CPA before you commit to anything.

Michael Plaks · Answer

This is absolutely a fact, given the OP's complex situation of multiple deeply appreciated assets brought into a 1031 exchange. Estimates are ok in straightforward situations such as buying a new property but not here. Which is also my opinion, just like yours.  ;)

Michael Plaks · Answer

No, Stanley, I do understand. I understand that you aggressively market your company's service. And you distort reality to fit your marketing goals. And dare to suggest that tax professionals with 30 years of experience "do not understand."

Yes, good cost seg companies coordinate with CPAs - when investor is already committed to the process and the cost seg company is hired. I'm talking about those free no-obligation preliminary estimates that are based only on basis and tax bracket. For simple situations, it is usually in the ballpark.

In complex situations like the OP described, knowing the basis and tax bracket is NOT ENOUGH. There are too many moving parts, and a responsible estimate in such situations cannot be done by cost seg providers, only by accountants.

Michael Tempel · Answer

Yes :-).   I am coming from a large syndication scenario.   Imagine doing this on a 3 million dollar renovation with a large building and 15 plus investors.    Huge way to produce immediate profit or benefits for investors.

of course there are times where it doesn't make sense, but in most cases we have done this.

Cost Segregation. Is it worth it?

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