1031 exchange into DST with a cost segregation study

[gsa11]

So, I had a client sell a rental property and 1031 exchanged into 4 DSTs.  The original property had a depreciable basis of $310K and $120K of that had been taken by the time of the 1031 exchange.  The leftover $190K basis I have prorated ($65K, $25K, $62K, and $38K) for each property according to the % of the purchase price listed by the 1031 exchange company.  My understanding is that I'm supposed to continue the depreciation schedule.  However, 2 of the DSTs have provided a cost segregation study and 2 did not.  Can I just continue the straight line depreciation on all 4 DSTs?  Do I have to use the cost segregations studies when they are provided or can I ignore them?  If I can continue the straight line depreciation from the relinquished property, what year am I starting from?  The relinquished property had 16 years of depreciation left.

I greatly appreciate your time and advice!

[TaxGuyBill]

---

@gsa11 wrote:

The leftover $190K basis I have prorated ($65K, $25K, $62K, and $38K) for each property

---

Wouldn't the Cost Seg items be coming out of those amounts?

[Strongsilence-CPA]

Cost seg studies are done to accelerate depreciation. They are advantageous to taxpayers.  I would not want to use my own method.

Depreciation starts on the date the DST was purchased.

[gsa11]

I would say that they CAN be advantageous depending on the individual taxpayer's numbers.

For the DSTs that didn't provide anything then I am restarting the depreciation over 27.5 years (or 39 because I think one of them is commercial storage unit place), correct? 

[gsa11]

My question was more about do you have to use the cost seg studies when they are provided or is it optional?

[TaxGuyBill]

In most cases, you don't want to make the election to restart depreciation.  In most cases you'll want to continue to depreciate the carryover Basis from the previous property (using the old placed in service date), then add a second asset to depreciate the 'extra' amount paid (using the new placed in service date).

You don't NEED to use the Cost Seg, but it can often be beneficial and your client paid for it, so why would you not want to use it?

[gsa11]

Is there a depreciation issue if the original property was residential and some of the replacement DSTs are commercial?  I feel like that would be a significant change.

[TaxGuyBill]

Hmmm, I didn't think about that. 

Generally, if a Residential Rental Property were to change to a Nonresidential Real Property, you would keep the original placed in service date but just switch to the longer Recovery Period.  See Regulation §1.168(i)-4(d)(4).  I would THINK the same would apply for a 1031 Exchange, but I'm not 100% certain.

https://www.law.cornell.edu/cfr/text/26/1.168(i)-4#d

[dascpa]

There is a potential IRS issue that has not been addressed [definitively] with 1031's and cost segregation studies. The goal of the cost seg is to apportion as much to quicker depreciation items like 5 and 7 year property. But 1031's are only allowed for real estate exchanges. 5 and 7 year property is not real estate but tangible personal property in most cases. If that's the case, do these categories still qualify as a real estate 1031?  This came from a 1031 class I took. The instructor felt that it was part of the real estate so it should qualify but also noted the IRS could rule otherwise under audit.  Makes you wonder.......

[TaxGuyBill]

---

@dascpa wrote:

 If that's the case, do these categories still qualify as a real estate 1031? 

---

I agree the that if that was part of the deferred amount it would be questionable.  However, in my opinion the 'extra' amount paid (non-deferred amount) should qualify for Cost Seg.

[gsa11]

Ooh, I'm feeling very special for stumbling across a non-settled area of practice!  (Also, feeling vindicated for my frustration when researching this.)

I would think that the IRS might ask the question of did the original 1031 property have those same 5 and 7 year property items included in it?

I checked one of the cost seg studies and did some back of the envelope math; it looks like using the cost seg study would actually lower the depreciation expense by $100 and create a lot more work for me.

[TaxGuyBill]

---

@gsa11 wrote:

I would think that the IRS might ask the question of did the original 1031 property have those same 5 and 7 year property items included in it?

I checked one of the cost seg studies and did some back of the envelope math; it looks like using the cost seg study would actually lower the depreciation expense by $100 and create a lot more work for me.

---

If I remember correctly, one of the Regulations say that 'other' stuff can fall into the exchange as long as it is only a minor portion of the sale.

I suspect you may have miscalculated something.  Switching some of the dollar amount from a long Recovery Period to a short Recovery Period will only increase depreciation, and even more so with Bonus depreciation.

Future years will have reduced depreciation, but the first year will have significantly more depreciation.

With that being said, how much it will benefit the taxpayer varies.  If it is a passive activity, the first-year losses may be carried forward until that is passive income.

[Strongsilence-CPA]

$100?  I don't know if you calculated correctly.  I suspect it was much more.

Interesting discussion and glad you are delving into it. 

You are special.

[gsa11]

Errors are always possible, but the study put more than 70% of the depreciation over 39 years (versus the 27.5 life that we had already lopped 11 years off of), another chunk into 15 years, and a relatively small amount into 5 years.

[TaxGuyBill]

---

@gsa11 wrote:

 the depreciation over 39 years (versus the 27.5 life that we had already lopped 11 years off of),

---

If it is Nonresidential Rental Property, you'll be using 39 years regardless if you use the Cost Seg or not.

The 15 year and 5 year items will increase the first year depreciation, especially if Bonus depreciation is used.