Real estate investors understand that a 1031 exchange allows them to defer capital gains taxes by rolling proceeds from one property into another. However, a common mistake in calculating the basis for cost segregation studies can quietly undermine the tax benefits, warns Brian Kiczula of CostSegRx.
According to Kiczula, the problem stems from incorrectly identifying the excess basis. In a 1031 exchange, the depreciation method from the relinquished property carries forward to the replacement property, creating a carryover basis. The only portion eligible for a cost segregation study is the excess basis, which represents genuinely new investment. Many investors and CPAs mistakenly use the transferred gain as the excess basis, but that is not the correct calculation. Using the wrong number risks disrupting the exchange itself, as the IRS requires accurate like-kind property treatment.
Cost segregation on a 1031 property is not always beneficial. If the replacement property is only slightly more expensive than the relinquished one, the excess basis may be negligible. Kiczula stresses the importance of calculating upfront whether a study will yield a benefit. “We need to calculate upfront whether there is a benefit for doing a cost segregation study because there’s not always one,” he said.
Collaboration between the cost segregation provider and the tax preparer must occur early, before the engagement begins. The provider needs more than the closing statement and 1031 exchange documents; they require the full fixed asset schedule from the original property, showing depreciation history and the exchange structure. Without this, any benefit estimate is incomplete.
Investors exploring cost segregation after a 1031 exchange should provide their provider with the closing statements from both the sale and acquisition, the 1031 exchange documents, and the fixed asset schedule from the relinquished property. This allows proper calculation of carryover basis and determination of excess basis existence.
Kiczula and CostSegRx offer complimentary estimates of benefit and work alongside investors and CPAs to ensure accurate numbers. The firm is an engineering-based cost segregation firm led by Brian Kiczula, a member of the American Society of Cost Segregation Professionals.
