By: KeyCrew Media
Online cost segregation calculators and rule-of-thumb percentage studies give real estate investors a false sense of security, according to Brian Kiczula, a real estate professional at CostSegRx. Studies generated without engineering-based asset analysis are often inaccurate, and they may leave an investor without the documentation an auditor asks for, exposing them to the scrutiny they were trying to avoid.
What a Revenue Agent Actually Looks For
The IRS does not audit cost segregation studies by checking whether the percentages look reasonable. According to Kiczula, a revenue agent reviewing a return with accelerated depreciation will look for documentation of the individual assets that were reclassified and will want to see replacement cost valuations for each one.
“The revenue agent is going to look for the individual assets that you pulled forward, and they’re going to want to see the replacement costs new, RCN, replacement costs new, or RCNLD, replacement costs new, less depreciation,” Kiczula says.
A rule-of-thumb study does not produce this documentation. It produces a percentage, say 30% of the building’s value in short-life assets, derived from averages across similar property types. That percentage may be directionally reasonable, but it is not supported by an asset-by-asset analysis, and it does not reflect the specific condition or characteristics of the property being studied. When an auditor asks for the underlying support, there is none.
“The rule of thumb method just doesn’t work,” Kiczula says. “It’s not something that would stand up if you were involved in an audit.”
The Problem With Instant Reports
Online calculators compound this weakness by making the process feel rigorous when it is not. An investor enters a property type, a purchase price, and a few basic details, and within minutes receives a report showing projected depreciation benefits. The speed and polish of the output obscure how little analysis went into it.
“If you’re strictly going online and you’re looking at a calculator, or it’s a DIY calculator that you’re entering the information in and it’s generating a report within a matter of minutes, it’s probably not a very comprehensive cost segregation study,” Kiczula says.
One of the most significant gaps in these tools, according to Kiczula, is the failure to apply depreciation factors to assets based on their condition at the time of acquisition. A parking lot that is 15 years old and approaching the end of its useful life is not worth the same as a new one, and that difference affects the depreciation calculation. The same logic applies to roofs, HVAC systems, and other long-lived components.
“A lot of the online tools don’t apply any depreciation factor,” Kiczula says. “You have to apply a depreciation factor to it. You also have to do the same thing to the rest of the components in the building, such as the roof or the HVAC systems.”
When Exaggerated Numbers Become a Red Flag
Studies that produce accelerated depreciation percentages outside the normal range for a given property type create additional risk. Whether generated by a calculator or an aggressive provider, numbers that look anomalous relative to comparable properties can draw IRS attention.
Kiczula notes that attempting to accelerate 75% or 100% of a single-family residence’s value in year one is the kind of figure that could trigger scrutiny. The issue is not that high percentages are always wrong (some property types genuinely do have substantial short-life assets) but that unsupported high percentages, without the engineering documentation to back them up, create audit exposure.
What an Engineering-Based Cost Segregation Study Documents
CostSegRx conducts engineering-based studies that identify individual assets, apply depreciation factors based on condition at acquisition, and record the valuation support behind each reclassification. The process involves examining the specific components of a specific property rather than applying industry averages, and building a study around what is actually there.
Kiczula also emphasizes the importance of being able to reach the provider when questions arise. “So many times, you’ll go online, maybe move forward with any type of product, but as soon as you have a question or something needs to be corrected, you can’t actually talk to a person that could help you walk you through the process,” he says. “When you’re specifically working with taxes, any financial type of products, you really need to be able to talk to the end provider.”
For investors weighing cost segregation options, the quality of the underlying analysis determines both the accuracy of the benefit and the documentation available if a return is examined. An investor who saves money on a cheaper, faster study may find that savings reversed, and then some, if the IRS asks for documentation the study was never built to provide.
About CostSegRx: CostSegRx is an engineering-based cost segregation firm led by Brian Kiczula, a member of the American Society of Cost Segregation Professionals. The firm works with residential and commercial real estate investors nationwide. CostSegRx provides complimentary estimates of benefit and supports investors and their CPAs through the full reporting process. Learn more at costsegrx.com or call (888) 850-4155.
