Residential Cost Segregator™ FAQs
1. How does a taxpayer determine the "land vs. building" allocation?
If IRS were to audit, they typically would first look to an appraisal to see if land was valued. If nothing exists, then they would look towards the county property tax assessor's allocation.
2. How does a Cost Segregation study affect AMT?
Depreciation deductions from a cost segregation study reduce Alternative Minimum Tax (AMT).
3. How far back can a taxpayer go to prepare a 3115 change in accounting method?
There is no limit on how far back you can go to claim missed depreciation deductions. However, at some point, the benefits will not make sense any longer with the age of the building/improvements. Generally, anything acquired less than 15 years ago is a good candidate.
4. Can I amend a return for cost segregation from last year?
Once an accounting method is established after filing two tax returns, you are required to file a 3115 to correct depreciation. If the property was acquired last year, you can amend last year's return to claim missed deductions.
5. What if my property was placed in service in a prior year and then subsequent improvements were done on a different date? What if the property was placed in service in phases on different dates?
The Residential Cost Segregator™ is not built to handle this situation because there are too many possibilities related to the scope of the subsequent improvements. However, the Residential Cost Segregator™ can still be used to provide a reasonable estimate of each asset's tax breakdown (provided that the total aggregate depreciable tax basis for improvements is less than $500,000). We recommend only entering the tax basis for the original acquisition. When the report is complete, the allocation %'s of each tax category (5 year, 15 year, 27.5 year) from the analysis could be applied to the subsequent improvements costs.For example, consider a building represented by two assets on the original depreciation schedule with asset #1 for $400,000 and asset #2 for $100,000. Using the $400,000 basis in the Residential Cost Segregator™ software, let's say the cost segregation report identifies 5 year property of $60,000 (15% allocation of the total). For asset #2 ($100,000), you would apply the same 15% to get 5-year property of $15,000.After you import the Residential Cost Segregator™ results into KBKG's 481(a) Adjustment Software, you can simply add a second original asset with a different placed in service date to represent the subsequent improvements. In the example above, you would create a second original asset (for the subsequent improvements of $100,000) with a sub-asset for 5-year property totaling $15,000 (15% allocation) and a sub-asset for real property of $85,000.
Additionally- anytime better information exists, such as construction invoices, the classification of subsequent improvements should be based on what was actually done to the building. For example, if you spend $5,000 on new carpet it can all be classified as 5-year property. If you remodel the restroom, it should all be classified as 27.5-year property.
6. Can you take the 179 expense on 5 and 7-year property from a cost segregation report?
Generally, the personal property from a cost segregation report is eligible for the 179 expense. However, it may not be eligible for 179 expensing for residential properties owned by passive taxpayers.
7. Can you do a 3115, for the current year return, after the tax return is filed and the extended deadline passed?
Once the extended due date has passed (9/15 or 10/15), you cannot file a 3115 for that tax year.
8. Can you perform a cost segregation study and file a form 3115 to take the additional depreciation in the same year as the sale of that property?
Yes, but recapture rules will apply. Therefore it almost never makes sense to do this.
9. Can you use cost segregation deductions to offset capital gain taxes from another property?
10. When doing a cost seg on buildings already in service in a prior year, would this involve a "change in accounting method" and/or an amended return?
You always have the option to file an automatic change in accounting method via Form 3115. No amending of returns is needed. An amended return can be done, but only if the building was acquired in the last tax year.
11. Why is Cost Segregation important to consider when someone dies and used for estate planning?
The key benefit of using cost segregation in the estate plan is after death the heirs get a "step up" to fair market value of the property and get to depreciate the same personal property over again. However, there is another opportunity that many CPAs overlook. This video explains how to create permanent tax deductions from a cost segregation study when someone dies.
12. When does an accounting method become established?
If you file two consecutive tax returns since the asset was placed in service, you have established an "accounting method" related to that asset.
13. What is the deadline to file the Form 3115 after the tax return is filed and in the same year?
You can generally file an amended/ superseded return to file a Form 3115 within 6 months of the original due date (that generally means it must be done before 9/15 or 10/15).
14. Can you perform a Cost Seg study on the residential home that I live in?
No. You are not allowed to depreciate residential property that is not used for business or income.
15. Does a taxpayer have to recapture the benefits from a Cost Segregation study upon the sale of a property?
Yes, there are three tax rates that may apply. Personal property from a cost segregation study is recaptured at ordinary rates (up to 38%), 1250 property is recaptured at 25%, Capital Gains Rate is 15-20%.
16. What is a 481(a) adjustment?
That is the tax code section that explains how to calculate the missed depreciation deductions. It is equal to the missed depreciation through the previous tax year (not through the current tax year).
17. If a taxpayer acquires a property to completely renovate, is this a good candidate for a cost segregation study?
If there is "intent" to renovate any part of the structure, the value of those components may need to be further discounted. For these situations, it is recommended to add the basis of any and all subsequent improvements to the total basis used in the Residential Cost Segregator. The Cost Segregation report allocations can then be used on each asset on the depreciation schedule.
18. Please list examples of personal property that is "re-classified" in a cost segregation study?
Decorative light fixtures, finished millwork/cabinetry, kitchen plumbing, and appliance hookups.
19. What is a passive investor?
One that is invested in real estate, but that it is not that person's full-time business or source of income
20. If a passive investor is paying taxes on his other business, can he use the deductions from the cost segregation report to reduce his taxes on his other business?
No, he cannot use passive losses to offset non-passive income. However, if he has other real estate properties, those would be considered passive and he could use losses from one property to offset income from another.
21. Does a cost segregation study impact the personal property reporting for Business Property taxes in states?
Maybe. Depending on the state, the definition of personal property may be vastly different. Consult your tax advisor or a local property tax expert.
22. If I did a 1031 exchange into a new property, can I do a cost segregation study on the new or old property?
Generally, yes but you generally need to step up significantly to make that work. Please read the following article The Interaction Between Cost Segregation and Like-Kind Exchanges
23. If a company currently has NOLs, is there any situation where they can benefit from CS?
A company can always increase their NOL's through the implementation of a CS study. Those NOL's carry forward. "Real Estate Professionals" can also carry NOLs backward.
24. How often can a taxpayer file a form 3115 for the same asset?
You must wait 5 years to file another 3115 on the same asset for the same issue. Example, you can't reclassify an asset from a 39-year tax life to 15 and then the following year change it from a 15-year tax life to 5.
25. How does the basis of the exchange property in a 1031 affect what is analyzed in a cost segregation report?
Cost Segregation separates the property in buckets, 1245 and 1250. The trade into property must be equal or greater in value for the assets in each bucket.
26. When performing a Cost Segregation study on a new building that was exchanged into, can the 1245 and 1250 categories be of lower value than the building sold in the exchange?
No, the categories must always remain equal or increase. If there is not an equal basis or a step up in basis, it will trigger recapture tax or "boot". Trading up is the general rule of thumb.
27. What criteria are used to determine if an asset is a 1245 property?
There is not one determining criteria that is used. Over the years, the courts have used several tests including: Is it necessary for the business? Is the property designed or constructed to remain permanently in place? Is the component necessary to operate the buildings? Additionally, is the property capable of being removed? Is it readily removable? How much damage will the property sustain upon its removal? Movability itself is not the controlling factor in deciding whether the property lacks permanence.
28. What are the 9 Units of Property for a building under the current repairs regulations?
For buildings, the Unit of Property is the 9 building systems defined: HVAC Plumbing Electrical All escalators All elevators Fire protection and alarm systems Security systems Gas distribution systems Other structural components identified in published guidance
29. Do countries tax the segregated personal property for personal business ad valorem tax?
Or is the whole building still counted as real property with one tax bill as real property? The definition of Real Property the county uses to determine property tax might not be the same as the IRS definition of 1250 Real Property, thus they may not be related or comparable.
30. If I own property in Mexico and Canada, can I do a cost segregation study on those properties?
It depends. Property held outside the US is subject to different depreciation rules that the Residential Cost Segregator does not currently support.
31. Does cost segregation apply for non-profit organizations?
No. Cost Seg reduces taxes so if no tax is being paid, cost seg does not help.
32. What is the Amerisouth Case and its impact?
Apartment cabinetry, plumbing, finish carpentry, stove hoods and electrical panels were ruled as not 1245 property, but the case is controversial due to Amerisouth selling the property and not following through on the lawsuit defense. Most cost segregation experts and even IRS officials believe this is base case law.