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What are the NEGATIVES?

 

1. They can be costly, often more than the tax savings of a CSS. So a cost feasibility study is paramount at the outset.
    
2. They are time consuming. If you have a time crunch, a CSS will not necessarily fit your timeline. Most take a few months to complete as site inspections, architectural documents, and other docs are reviewed and analyzed.
    
3. Depreciation is recapturable – meaning, depreciation is “borrowed” money, interest free. This is true whether or not you do a CSS. At the time of sale of your property, depreciation gets added back to your purchase price + improvements to determine your total cost (“adjusted cost basis”) of the property. But time value of money is more important and is what makes depreciation worth it. Specifically, the tax savings received TODAY from PROPERLY allocating the cost basis of the building and its various components to the correct buckets through a CSS allows you to later redeploy those tax savings to pay down debt, make capital expenditures, return monies to investors, or hold on to it for deferred maintenance (future repairs) or a downpayment for a new purchase. More depreciation now means more cash in your pocket today to make more money off of, even though you have to return that depreciation when you sell the property. When you sell the property, you can also choose to allocate the sale of the property MORE towards assets which have longer lives (building, for eg), and which have not been depreciated as fast as other smaller assets have through bonus depreciation (plumbing, HVAC, for eg). So that’s a big mitigator right there!
    
4. IRS Audit Risk: Yes, this was mentioned as a benefit, but only if you have a poorly or hastily done CSS, or one from a nonqualified firm, both can increase the audit risk and, thereby, penalties and back taxes. That is why it is important to not only choose the correct firm, but to have all relevant documentation about the cost of the building, repairs, installation, labor, architectural docs, plat of survey, tax records, etc. A DIY (“do-it-yourself”) cost segregation can lead to many problems, such as it being not accurate, not being done by qualified engineers and tax professionals, lacking proper documentation, taking too long, not complying with proper IRS valuation methodology, amongst other things. Studies not tied to actual construction costs and use of overly aggressive asset classification are other audit risk aggravators. The IRS Cost Segregation Audit Technique Guide is the 348-page document which outlines what the IRS looks for. In the end, your CSS should be able to not only stand on its own legs, but come from a firm who can help explain and substantiate the calculations, findings, and approaches used in it, which will give you the confidence that you can get through an IRS audit.
    

5. Income Tax: Yes, you will eventually have income tax if you SELL the building, if there is a capital gain, and you might have substantial depreciation recapture, even after applying the strategies in point 3 above. That’s when you look to do an Internal Revenue Code Section 1031 transaction, buying a separate like-kind property to DEFER the gain.
   Read more about that here: https://tax.thomsonreuters.com/en/glossary/1031-exchange
   
   A further mitigator to income taxes upon sale and depreciation recapture is qualified opportunity zones, made permanent by OBBBA. Your capital gains are essentially deferred for a few years, and any new capital gains from a QOZ can be tax free, provided you keep the investment in the QOZ for the requisite period.
   Read about that here: https://tax.thomsonreuters.com/news/irs-releases-faqs-explaining-qualified-opportunity-zone-final-regs/