- What is the process for obtaining a cost segregation study?
- How much does a cost segregation study cost?
- What should I expect to receive upon completion of a cost segregation study?
- Should items purchased after the original closing be included on the cost segregation report?
- I noticed that some items (e.g. ceramic tile, wood flooring, bathroom vanity base cabinets, etc.) are missing from the report? Is this a mistake?
- How do I determine my cost segregation property basis for the cost segregation study?
- I purchased a property, made improvements, and then refinanced. Which value do I use for the property basis?
- What if I realize after the cost segregation reports have been generated that I provided Redtec Solutions with an incorrect property basis?
- Can I put multiple property addresses into one report?
- How are replacement costs determined?
- I only plan to hold my property for 1 year. Is it still worth getting a cost segregation study performed on my property?
Troubleshooting Questions:
General Questions:
General Cost Segregation Questions:
Q: What is cost segregation?
A: Cost segregation is an accelerated depreciation technique that sophisticated real estate investors use to reduce their tax burden and increase after-tax cash flow. Cost segregation is accomplished with a cost segregation study.
Q: What is a cost segregation study?
A: A cost segregation study is a comprehensive analysis whereby personal property assets and land improvement assets are identified and segregated from real property assets for tax reporting purposes. According to IRS Publication 946, “Appliances, carpets, furniture, etc., used in a residential rental real estate activity” can be classified as “5-year property” and depreciated using the “200% declining balance” method. In addition, “certain improvements made directly to land or added to it (such as shrubbery, fences, roads, and bridges)” can be classified as “15-year property” and be depreciated using the “150% declining balance” method. These 5 and 15 year asset class buckets result in accelerated depreciation, which reduces the investor’s tax burden and increases after-tax cash flow.
Q: What are the benefits of a cost segregation study?
A: A cost segregation study provides:
- Increased cash flow through accelerated depreciation write-offs.
- An opportunity to claim ‘catch-up’ depreciation on previously misclassified assets without having to amend a prior tax return.
- The potential for little to no recapture of the 5 and 15 year asset classes upon disposition (please consult your CPA).
- Information that is valuable in managing capitalized assets.
Q: Is cost segregation legal?
A: Yes. Please refer to IRS Publication 946 and the IRS Cost Segregation Study Audit Techniques Guide for more information.
Q: Why haven’t I heard of cost segregation before?
A: Cost segregation studies for sophisticated real estate owners have been around since 1997. Since then, the “Big 4” accounting firms and a select group of other national and regional accounting firms have used cost segregation for their wealthier real estate clients. It has only been within the last few years that this application has been made available to smaller properties.
Q: What are the most common methodologies utilized for cost segregation studies?
A: According to the IRS Cost Segregation Audit Techniques Guide, there are 6 different methodologies:
- Detailed engineering approach from actual cost records.
- Detailed engineering cost estimate approach.
- Survey or letter approach.
- Residual estimation approach.
- Sampling or modeling approach.
- “Rule of Thumb” approach.
Our methodology most closely resembles the detailed engineering cost estimate approach. Our personal belief is that the first two approaches are the best and most easily supported in the case of an IRS audit, and that investors should be wary of Cost Segregation companies that use one of the last four approaches mentioned above.
Q: If I get a cost segregation study done on my property, will it increase my chance for an IRS audit?
A: A cost segregation study will not increase your chance of an audit, provided it is done properly. The IRS provides guidance on this subject. In chapter 4 of the IRS Cost Segregation Audit Technique Guide, the IRS establishes the 13 principal elements of an acceptable Study. At Redtec Solutions, we believe our report meets all of these elements. For a property that has been depreciated on prior tax returns, the cost segregation study will require the filing of IRS Form 3115 (“Application for Change of Accounting Method”). The IRS has pre-approved the use of IRS Form 3115 as long as it is filled out correctly.
Q: Who should consider purchasing a cost segregation study?
A: Any investor that owns income producing real estate should consider a cost segregation study. Depending on the investor’s federal marginal tax bracket, tax situation, basis in the property, and amount of personal property/land improvements, the benefit of the cost segregation study (in terms of tax savings) typically more than offsets the cost of the study in the year the study is completed. Please refer to the Powerpoint presentation for a real life example.
Q: What size property is needed to do a Cost segregation study?
A: In general, it depends on how expensive the study is and how long you will hold the property (to realize the benefit of the study). When using Redtec Solutions, we believe that cost segregation studies are most cost effective on residential properties that are purchased for $100,000 or more.
Q: Can I still perform a cost segregation study if I have owned a property for several years?
A: Your property is eligible for a cost segregation study if:
- It was purchased after 1986, or
- It was newly constructed after 1986
Since 1996, taxpayers can capture immediate retroactive savings on property added since 1987. Previous rules, which provided a four-year catch-up period for retroactive savings, have been amended to allow taxpayers to take the entire amount of the adjustment in the year the cost segregation study is completed. This opportunity to recapture unrecognized depreciation in one year presents an opportunity to perform retroactive cost segregation analyses on older properties to increase cash flow in the current year. For more details, please consult your CPA.
Q: Can I still use a cost segregation study if I have reported personal property for this rental on a prior year’s tax return?
A: There are two cases to address here:
- If you have specifically identified certain items with a value on your prior tax returns (i.e. refrigerator $400, stove $350, etc.), then the reported values cannot change for these items. However, you will likely still benefit from a report since you may identify additional items that were not segregated on a prior year’s tax return. These would be added to the current year return and the building value reduced accordingly.
- If your previous tax return used a “lump” sum amount (e.g. personal property $2700), then you can use the cost segregation study as substantiation for the original amount and add specific property/amounts over the original amount to get the remaining depreciation. These would be added to the current year return and the building value reduced accordingly.
Keep in mind: If the rental property has been depreciated on a prior return, you are required to file IRS Form 3115 (“Application for Change of Accounting Method”). This notifies the IRS that you have made changes to the depreciation method used previously and allows you to take additional depreciation expense in the current year, since you can take accelerated depreciation for prior years all at once. Please consult your CPA.
Q: What if I have a technical cost segregation question that is not answered elsewhere in this FAQ?
A: Please contact our “Technical Questions” specialist.
Specific Cost Segregation Questions (relating to Redtec Solutions, LLC):
Q: What is the process for obtaining a cost segregation study?
A: The process is as follows:
- Create an account profile on www.redtecsolutions.com.
- Order a cost segregation study on www.redtecsolutions.com.
- This will involve filling out a property-specific questionnaire and agreeing to our terms of use.
- Based on the property location, and when the report is needed, we will provide you with an estimated completion date.
- Arrangements are made with the owner, tenant, or property manager to gain access to the subject property to perform the cost segregation study.
- During the site visit, measurements, notes, and photos are collected.
- The data is then used to create your customized reports, which will be uploaded to our secure server upon completion.
- You will be notified via email of the completion of your reports and will be sent an invoice.
- Upon receipt of payment, you will have access to download your completed reports and photos from our secure server.
Q: How much does a cost segregation study cost?
A: Redtec Solutions charges the following for studies performed in Arizona:
| Type of Unit | Cost |
| Single Family Home, Condo, or Townhouse | $1,500 - $2,500 |
| Duplex | $1,800 - $2,800 |
| Triplex | $1,900 - $2,900 |
| Fourplex | $2,000 - $3,000 |
Redtec Solutions will also perform cost segregation studies throughout the rest of the United States; however a trip charge may apply. Please contact us directly for properties outside of Arizona.
Q: What should I expect to receive upon completion of a cost segregation study?
A: Redtec Solutions will provide you with two downloadable reports. One is an itemized list of all personal property and land improvements in your investment property. The second is the finalized cost segregation report that should be turned over to your CPA. You will also have the ability to download representative pictures of your personal property/land improvements. Both reports and the pictures will be stored on www.redtecsolutions.com for 3 months. Alternatively, Redtec Solutions will store all reports for a client on www.redtecsolutions.com indefinitely for $50/yr.
Q: Should items purchased after the original closing be included on the cost segregation report?
A: Items purchased after the original closing should be accounted for and depreciated separately in the year they were purchased. Therefore, they should NOT be included in the cost segregation study. This would include scenarios where:
- The property was purchased new and many items such as window treatments, appliances, landscaping, pool, etc. were added after closing.
- Major renovations were completed after closing. The assumption here is that if an item required replacement (e.g. carpet, stove, etc.), it had little or no value when purchased with the property.
Q: I noticed that some items (e.g. ceramic tile, wood flooring, bathroom vanity base cabinets, etc.) are missing from the report? Is this a mistake?
A: Some items in a property may be depreciable, but are not considered personal property or land improvements and are therefore excluded from the report on purpose. Items that are permanently affixed to the property are not considered depreciable personal property such as ceramic tile or wood flooring.
In addition, some items that are considered personal property/land improvements may not qualify based on where they are installed. For example, according to the IRS, bathroom vanity base cabinets are not considered personal property, which is why the bathroom section of the report contains very few items. These items have been excluded from the report by design.
Our staff will continue to monitor evolving tax case law in this area and our reports will reflect these changes.
Q: How do I determine my cost segregation property basis for the cost segregation study?
A: Please consult your CPA. Since capital improvements should be isolated and depreciated on their own schedules (i.e. not included in a cost segregation study), the cost segregation property basis for non-1031 exchange purchases should be the purchase price plus all title-related closing costs. For 1031 exchanges, your CPA will also account for the carryover basis (which includes previously taken depreciation). Note that the “cost segregation property basis” is different than the property basis your CPA will use for property disposition tax purposes, because it does not include capital improvements.
When you order a cost segregation study from Redtec Solutions, we ask if there were any capital improvements that you made to the property for this reason.
Q: I purchased a property, made improvements, and then refinanced. Which value do I use for the property basis?
A: The appropriate value for the property basis should be based off of the original price, and not the refinanced value. Please consult your CPA to calculate the correct property basis.
Q: What if I realize after the cost segregation reports have been generated that I provided Redtec Solutions with an incorrect property basis?
A: Please consult your CPA. Your CPA should be able to easily account for a different basis if the property was purchased (i.e. not 1031 exchanged). The cost segregation report will contain total monetary values for the 5 year personal property bucket and the 15 year land improvement bucket. These values are based on existing personal property/land improvements that came with the house and should not be influenced by the property basis. A change in property basis will only change the 27.5 year real property bucket. If your basis is incorrect due to a 1031 exchange in which a prior cost segregation was performed, then your CPA will have to use one of the two “carryover basis transaction” methods outlined in the technical article entitled: “Analysis of New Temporary Regs For Depreciating Replacement Property in Nonrecognition Exchanges” by Louis S. Weller and Dean A. Halfacre that was published in the May 2004 issue of RIA/WGL Journal of Taxation.
Q: Can I put multiple property addresses into one report?
A: No. The IRS requires that each unit within a property address be valued separately. Putting more than one property address in a report will make the report invalid.
Q: How are replacement costs determined?
A: Replacement costs are determined by using Marshall & Swift’s cost replacement tables (Marshall Valuation Service). The Marshall Valuation Service is recognized in the IRS Cost Segregation Audit Technique Guide as a legitimate cost estimation service.
Q: I only plan to hold my property for 1 year. Is it still worth getting a cost segregation study performed on my property?
In most cases, yes it is. Consider the example outlined in slides 21-24 of the MS powerpoint presentation. If you look at slide 23, you will see that the incremental after-tax benefit of cost segregation for this ~$227,000 property in the first full tax year
is $1,502.81 (assuming the 25% Federal marginal tax bracket). The return in year 1 will comprise of both the $375 tax savings associated with writing off the cost segregration study (0.25 * $1500) and the $1502.81 of incremental after-tax benefit received by performing the cost segregation study.
Therefore, the $1500 expense today will yield a combined return of $1877.81 in one year, which is a 25.2% return on investment (IRR)! As you can see, even holding the property for only 1 year provides a tremendous return on investment. Please consult your CPA to see how practically applicable
this example is to your personal tax situation.
Troubleshooting Questions:
Q: What if I have problems viewing or printing the reports?
A: Use the following troubleshooting steps:
- Make sure you have the latest version of Adobe Acrobat Reader installed.
- Check that your printer is properly configured. Test by printing another unrelated PDF.
- Check your system for software designed to block pop-ups. Temporarily disable your pop-up blocker or enter www.redtecsolutions.com as a trusted site.
- Contact our web administrator.
Q: How do I change my password?
A: Login to www.redtecsolutions.com with your username and password. Then click on “Edit Personal Information”, followed by “Change Password”.
Q: What if I encounter a problem or bug with your website (www.redtecsolutions.com)?
A: Please contact our web administrator.
Q: What if I encounter a gross mistake with the report (e.g. the report identifies personal property and/or land improvements that you do not have, reflects a quantity that does not exist, etc.)?
A: Please contact our “Order-Related Questions” specialist.
General Questions:
Q: Why choose Redtec Solutions?
A: Redtec Solutions is the only cost segregation company (to the best of our knowledge) that only focuses on residential 1-4 unit investment properties. We are the residential specialists at an extremely affordable price! The owners possess multiple engineering degrees. Our staff has many years of experience and extensive knowledge in this very specialized area. We are passionate about exceeding your expectations, and strive to develop lifelong relationships with our customers.
Q: What do you do with the information I give you about myself or my property?
A: We use your personal information to develop a customized login for you and contact you should we have questions with your order(s). We use your property information to customize and calculate the cost of your cost segregation reports. We do not sell or share this information with anyone who is not associated with the production of your report. For more information, please consult our privacy policy.
Q: What is your return policy?
A: Upon submittal of a cost segregation study order, you will receive an estimated completion date. You may rescind your order in writing (by emailing info@redtecsolutions.com) anytime prior to our site visit. Once the cost segregation study has been started however, no refunds will be issued.