Hype Or Opportunity: Cost Segregation


Cost segregation is a tax saving method that apparently has caught on with the opportunity sales people. I know I get a spam or two a week telling me I can make jillions of dollars by marketing cost segregation to the local business community. Since I receive so many solicitations I’m beginning to believe this tax cutting method has become diluted and now borders on farce.

I say diluted and borders on farce because I’m willing to bet the purveyors of this opportunity have driven the cost through the roof for the business person. I’m also thinking that if I was a businessman holding commercial real estate I’d already be using a CPA who knew about cost segregation. After all, when I studied accounting in college in the 1970’s we had to know about the lives of assets and the different depreciation schedules and write off periods.

It seems nothing has really changed except maybe the liberalization of some of the rules the IRS/Congress create regarding depreciation and its attendant write off periods. I could be wrong but I don’t think so.

The Essence of Cost Segregation

Cost segregation carves out shorter lived assets, which qualify for five, seven and 15 year write off periods. These are normally embedded in a building’s construction or acquisition costs. These would normally be depreciated over 39 years except cost segregation reclassifies these assets and accelerates the depreciation. This brings about tax savings and easier write offs when assets become obsolete.

For the life of me, wouldn’t your CPA or accountant already know this? Yes, if they stay on top of the latest changes to the tax laws. If they don’t, would you really keep paying them?

Back To Opportunity Or Hype

Since this method seems to work best only on properties valued at $1 million or more, it would seem to me the opportunity offering genre are selling a program that is behind the times and not exactly a money maker to the person who buys into the hype. Let me state that that is my opinion but it is based on what I know about the tax laws and the practitioners in the tax preparing arena.

If anyone has more detailed information on this opportunity as to how it really works ( I don’t mean cost segregation, I mean how you sell it), I’d like to hear it. After all, if it is for real, I’d venture the opinion there are business people willing to listen to the presentation.

Just my 2¢ on an opportunity in this wonderful world of real estate.

Photo Credit: tanakawho

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  1. Hi — we’ve done CSS’s on all 7 of our new properties. They’re only SFR’s worth about $165k/each. The biggest issue for us was that cost to do the study. We had one firm charge $645 and the other was $795. For this cost we were able to shift $40k (average per house) worth of deprecation from 27.5 into 5 and 15. We ran the numbers based on the present value (PV) of the cost and our estimated hold time of 15 years (exit strategy and mortgage length) and it made sense to us. We did get quotes from the big guys but they wanted way too much for the work. So, as usual. It depends. If the cost is high, then no. If the cost of the study is reasonable, then go for it. The key is to get a good sample of the savings (from a prior customer) that is very similar to your building, and then run the PV numbers to assure that your dollars are well spent.

    oh, and our properties are in the GO Zone, so the numbers looked even better for us.


    • $645 and $795 is way too cheap. You’re probably going to get audited because whoever performed those likely 1) does not have a license from the IRS; 2) did NOT perform an engineering-based study; and 3) will disappear if/when you get audited!

      • So far it’s been 7 years, and not a peep!

        With most of the accelerated depreciation (including the bonus) taken at this point (only the 15yr schedule is left then we go for a 1031) — I’d say we’ve been VERY successful with running our business in a legal and tax efficient manner.

        We also did our due diligence with the Company in question (no longer in business), and felt they had under-priced their product just as YOU noted. Maybe it’s not lack of quality, but just a simple miscalculation and our timing was excellent?

        How about giving THEM a break buddy?

  2. Tim,

    You have just underscored a cardinal rule: Shop till you drop when it comes to pricing a financial service. And, as you say, bigger sometimes only means a bigger price tag to do the same thing a less expensive service can do for you.

    I am pleased to hear it worked out for you. Congratulations. The money really does look better in your pocket, doesn’t it?

  3. Sure does. Thank goodness for the internet; helped us find the players, sent an RFP right on their webpage, and we got a reply within a few days. No long sales talks on the phone or waiting for the brochure in the mail. Quick and successful. Efficient for them, efficient for us. The only ‘regret’ we have is that the folks we did hire were a little lax when it came to quality control, like so many small companies these days, so every one of the 7 had to be re-worked. The biggest deal was that they could have saved themselves quite a bit of time and money if they would have just sent us a preview via email rather than overnight (not our request) the “package” which were promptly returned to fix this or that. We didn’t care for the pretty package, we just wanted the numbers. Just a lack of attention to detail mostly. But, the IRS says you have to have a qualified/independent company do the work, so we make it happen.

  4. Cost Seg has become under a lot of IRS scrutiny (due to the saturation you alluded to). Too many out there taking advantage of the market place and doing very poor jobs. Anyone having a firm do it in the ‘hundreds’ should be very nervous in case of audit. The reason CPA’s don’t do this is because it is an Engineering Study. Granted, on new builds CPA’s can estimate and come pretty close, but will it withstand IRS scrutiny if they are incorrect? For example, what depreciation should the mechanical components of an elevator have in an apartment complex? The belts? The lights? The hardware? The carpet?

    If you truly want to be protected and get the maximum depreciation allowable, it’s best to have a true Engineering Cost Seg Firm do the work. You should always get an ROI of at least 10:1 which makes financial sense for most and you will be fully protected in case of audit.

    If you like to use your CPA estimates and hope the IRS never comes a knockin, stick with that route.

    My two cents! 🙂

  5. The IRS actually published audit guidelines for cost segregation in 2004. They have requirements for a compliant study. Compliant, fully engineered studies are generally not coming under the scrutiny of the IRS. Rather, “template studies”, which clearly do not adhere to IRS guidelines, are coming under scrutiny.

    Cost Seg is just about the “last man standing” as a bona fide method of pulling money out of real estate holdings in this environment. Simply, it’s all about net present value of the tax benefits. if the net benefit is greater than 10 times the cost of the study, it usually makes sense. Larger buildings will have a ratio of 18-25X….a very compelling value proposition. An engineered study will usually yield more benefits than an accounting based study. Why? A CPA is not trained to read blueprints, as built drawings, etc. Cost seg is really an IRS guidelined, engineered technique that yields a tremendous tax benefit.

  6. Haven’t had to do anything. The CS study pretty much just set the depreciation schedule, and the apportioned amount for that year helps reduce our taxes — so we haven’t had anything to do with it for a while now. The objective of the CS study was to bring up all that depreciation into the timeframe we were going to own the house(s), not after. They are financed in 15 year fixed, which happens to exactly match the last ‘major’ depreciation schedule end point before the 27.5 max. For that, the CS study did its job, and was well worth the money, though I haven’t tried to calculate the exact ROI. YMMV.

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