General Cost Segregation Questions:
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.
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.
A cost segregation study provides:
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.
According to the IRS Cost Segregation Audit Techniques Guide, there are 6 different methodologies:
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.
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.
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.
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.
Your property is eligible for a cost segregation study if:
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.
There are two cases to address here:
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.
Please contact our "Technical Questions" specialist.
Specific Cost Segregation Questions (relating to Redtec Solutions, LLC):
The process is as follows:
A cost segregation study can range from $2,000 to several thousand dollars depending on the property type, size, location, and amenities. Please contact us for more information.
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 redtecsolutions.com for 3 months. Alternatively, Redtec Solutions will store all reports for a client on redtecsolutions.com indefinitely for $50/yr.
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:
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.
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.
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.
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.
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.
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.
In most cases, yes it is. Consider the example outlined in slides 21-24 of the 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.
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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.
Upon submittal of a cost segregation study order, you will receive an estimated completion date. You may rescind your order in writing (by emailing [email protected]) anytime prior to our site visit. Once the cost segregation study has been started however, no refunds will be issued.