All Forum Posts by: Paul Caputo

@John Acheson it depends on the specifics of the property if you should take advantage of cost segregation or not. The bigger the better as @Nicholas Aiola pointed out, but we can generally find enough benefit for it to make sense on property with a building value over $200,000 and sometimes as low as $100,000! It'll be a lot more benefit on a $1mm+ property, but the tax code doesn't have any minimum value for cost seg.

If you try to do it yourself you will lose under audit 100% of the time. Cost seg requires both construction knowledge and tax knowledge as in a construction engineer trained in the tax code. 

If you have any questions or want to see some numbers feel free to PM me! 

Doesn't matter when it was built. Only matters when you bought it. Depreciation starts the month its placed in service meaning ready and available to be rented (regardless of if it's rented or not). The land value is not depreciable, only the building value counts for depreciation. You'll depreciate that over 27.5 years. 

If the building value is high enough you should consider cost segregation to break out the assets into 5 year, 15 year and 27.5 year depreciation, but on a 50 year old duplex it's probably not going to make sense to do that. 

@Craig Poskus Publication 527 doesn't help much on this because there are no bright line tests for what qualifies as a 5 year asset or a 27.5 year asset. It's a lot more complicated than "this is always 5 year, that is always 15 year and those are always 27.5 year" since the determination is based on 6 factors meant to test permanence. It's all based on the facts and circumstances of the particular property and each individual asset. Other than the main structure of the building most other things inside could go either way. 

To be done properly cost segregation must be done by a qualified construction engineer trained in the tax code as it pertains to depreciation. On a project where you've put in that much in upgrades you owe it to yourself to have the cost segregation done right. 

It's a great start that you have all the receipts and excel list, but you need to have a professional take a look if you want something that would be defensible to the IRS.

To answer your questions: windows are generally considered structural so they'll be 27.5 year (unless they're a part of a 5 or 15 year asset - rare but possible), the floors depend on what they are and how they're installed, carpet and laminate are generally 5 year, solid hardwood and ceramic tile are generally 27.5 year, the deck could be 15 year or 27.5 year depending on how it was installed.

If you'd like to have an in depth discussion on this and see some numbers PM me.

I'm not a CPA, but I'd recommend talking to a few locally that understand real estate. That's your best bet to get this mess cleared up. 

I'm guessing you took some special depreciation deductions or did cost segregation since that's way more depreciation than you'd get in 14 years on that property using the straight line method. Depreciation recapture is maxed at 25% on real property (it's more complicated if you pulled out personal property) So with $2.3mm depreciation recapture the tax bill would be $575K on the recapture assuming it's all real property, it'd be higher if you pulled out personal property unless you were proactive on mitigating that which it doesn't seem like. Then you have a $140K loss from the purchase price to the sale price which would mitigate some of the recapture and there wouldn't be any capital gain. Add the carryover loss to that and you should be pretty close to no tax liability, but I'm no expert on how carryover losses work you may not be able to use it here. And that doesn't even take into account the closing costs and improvements. 

These forums are great to learn, get advice and seek second opinions, but this situation is way too complex to be figured out on the forums. Talk to some more CPAs and get a second or third opinion, that's the only way you'll get this taken care of. 

@Bob Flynn 25% land value is pretty common, but it's right for you to question the allocation. I've seen everything from less than 10% land value to over 50% land value depending on the location and specifics of the property. 

The tax code says you may use any reasonable method to allocate land value and improvement value, noting that the fair market value of assets at the time of purchase is preferable. So whatever you do you have to back it up with the facts and circumstances of the property. @Logan Allec is spot on with his post, the IRS and the local tax assessors are not always right when it comes to the land/improvement allocations.

While your CPA may have referenced the tax assessment and found a 25% land value it's possible they just went with 25% land value as an average in which case you can probably do better. I'd look up the tax assessment myself if I were you. Beyond that look at comparable property and get an appraisal that includes land value and improvement value. That way you have numbers and an expert opinion to back up your allocation in the unlikely event of an audit. 

Whatever you do there is absolutely no way to claim the land is worthless or you bought it for less than nothing. Destruction of the land would be the only way to argue that land has no value. Land is a finite resource and intrinsically has value no matter how good of a deal you got in purchasing the property. The improvements would not exist if the land was not beneath them. 

@Karen Higgins With a $600K property you should see a good benefit, but the bigger the better with cost seg. If you have 20% land value on that property you've got $480K depreciable cost basis. If it makes sense for you depends on your situation. If you want to lower or eliminate your current tax liability it makes sense to take a look and see what's possible. Since you're a real estate professional doing long term buy and hold and have over 70 units it's likely you'll see a huge benefit from cost segregation.

The reason it's been difficult to get clear answers from the accountants you've spoken with is that cost segregation is not their area of expertise. Accountants generally do not have construction knowledge. To be done properly cost segregation should be done by a construction engineer or architect with knowledge of the relevant tax code. That's the first principal element of a quality cost segregation study. 

https://www.irs.gov/businesses/cost-segregation-audit-technique-guide-chapter-4-principal-elements-of-a-quality-cost-segregation-study-and-report

A "mini" cost seg is basically a residual estimation, which is cautioned against by the IRS because it is generally inaccurate. They don't require any particular method, but they do require it to be accurate. Unless you built the property yourself and have all the invoices it's quite difficult to segregate costs since everything must be reconciled to the total cost. The only way to really be accurate is a detailed engineered cost segregation study. 

The biggest detriment on building wealth is paying taxes. That's why it's so important to take advantage of every allowable strategy to defer or lower tax liability. It's not about cheating the IRS, it's about using the rules to your advantage. Most people don't and end up significantly overpaying taxes. 

As far as I know there hasn't been any established guidance yet on if personal property within real estate is allowable or not for a 1031. If it's still allowable then nothing has changed. Under the previous rules (which may still apply, we don't know yet) you needed to have equal or more 1250 property AND 1245 property to avoid any boot. If exchanging the 1245 property ends up being no longer allowable there will likely be an increase in partial dispositions and retirement of 1245 property or valuations showing that the 1245 property has little to no value. While these are already great strategies to significantly lower or eliminate recapture on 1245 property they would become almost necessary in a 1031 where they previously weren't. 

Since the main point of the new tax law was to lower taxes on business and investment I think once it all washes out there isn't going to be any change regarding 1031's and cost segregation, remember most members of congress own property and they want the tax benefits of real estate as much as we do. 

Unless your hold period is short and/or you jump several tax brackets between original purchase and eventual sale (1031 or otherwise) time value of money always wins! If either of those is the case you shouldn't be considering cost segregation in the first place; wait until you jump brackets then do a look back study to get the adjustment. I've had to tell several potential clients to wait until it makes sense. 

Getting a $100,000 deduction in 2018 dollars and then repaying the same $100,000 deduction in 2038 dollars is a no-brainer. Those dollars will be worth much less in 2038. It's simple inflation. Other than those two situations above it makes way more sense to take that $100,000 deduction and reinvest it now rather than taking it over 39 or 27.5 years, each year that deduction is worth a little less even though it's the same dollar value. In the long term time value will always beat inflation. Plus look at the opportunity cost of reinvesting vs paying taxes.

It takes some creative structuring beyond my expertise, but I know there's at least 2 ways to significantly lower or virtually eliminate capital gains and recapture with or without a 1031. Some of it makes me go wow how is that legal, but it's black and white in the tax code and passes audit. With that it does take a very savvy tax attorney to get that stuff setup properly.

But as always, talk to a real estate tax attorney and a real estate CPA as well as a qualified cost segregation firm like mine or @Yonah Weiss. And make sure everyone understands everything, It's very common to hear "don't do that" when it's misunderstood.

You're looking at capital gains and depreciation recapture. Hopefully you've taken the depreciation the past 4 years and gotten that tax benefit since the IRS is going to recapture depreciation that's "allowed or allowable" either way if you did or not. If you didn't you can file Form 3115 to "catch-up" on missed depreciation and then it'd basically be a wash on depreciation: the tax credit and tax due would cancel each other out UNLESS your marginal tax rate is higher than the 25% recapture max in which case you'd get more tax credit than tax due. 

Other than a 1031 you can't avoid capital gains without doing some really fancy accounting tricks or a bargain sale, and that wouldn't make sense on one rental that's appreciated well like that.

@Dave Foster is right, if you're considering buying another investment property definitely look into a 1031. The best way to build wealth is to defer taxes as long as possible!

@Account Closed since we only do forensic detailed engineered cost segregation our audit rate is extremely low. We've done over 14,000 cost segregation studies and we've never had a client audited due to our work. We've had 4 clients audited from random lottery and our defense has always resulted in 100% success, meaning that all our studies have been "unchanged" - we've never given a penny back to the IRS. We include audit defense at no extra charge with every study even though an audit is extremely unlikely. That's less than a 0.03% chance of audit compared to the average 1-3% chance of audit. 

I can't speak to the audit rates of other firms, but I do know that several non-forensic firms have been put out of business because they have failed several audits. We're one of only 14 forensic tax engineering firms in the country that can provide such a high level of service and accuracy. Non-forensic firms may have lower fees, but they cannot provide significant audit protection or the maximum allowable tax benefits of a forensic tax engineering firm. 

@Matt H. were those forensic detailed engineered studies? Most people don't realize that all cost segs aren't done the same way. The IRS describes 6 different methodologies: detailed engineering from actual cost records, detailed engineering using cost estimation, survey or letter, residual estimation, sampling or modeling and rule of thumb. The detailed methods are the most accurate, most defensible and get the most benefit. The IRS doesn't require any particular method, they just require it to be correct which isn't so easy with the other 4 methods. 

It's important to make sure you're getting it done right and protected in case of an audit.