Interaction with 1031 Exchanges

Cost segregation and 1031 exchanges are two of the most valuable tax planning strategies available to commercial real estate owners today. Through proper tax planning, both of these tax-deferral techniques can be used on the same property in order to obtain the maximum tax benefits.

SIMILARITIES BETWEEN COST SEGREGATION & 1031 EXCHANGES

• Both are used to defer taxes and therefore improve cash flow
• Both can be performed on every type of commercial property
• Both strategies can be used on the same property
• Both encompass complex areas of tax law and require the help of specialists*

*1031 exchanges require a “Qualified Intermediary” to perform the transaction and ensure proper execution.

*Cost segregation studies require an engineering-consulting firm to perform and validate the study.

TAX PLANNING AND EXIT STRATEGIES

1. An Ernst & Morris cost segregation estimate helps determine if a study will be beneficial for the replacement property, given the carryover tax basis. Generally, cost segregation studies are most advantageous when the building owner is exchanging up in value, or exchanging from land to a building.

2. Consider depreciation recapture resulting from the cost segregation study if the property is to be later disposed of in a Section 1031 exchange. Building owners should plan for the possibility of future depreciation recapture, which requires paying some tax in the later exchange. However, recapture can be avoided altogether by acquiring replacement property with sufficient amounts of Section 1245 property.

WHERE TO LEARN MORE ABOUT THE INTERACTION
OF COST SEGREGATION AND 1031 EXCHANGES:

"The Best of Both Worlds"
Journal of Accountancy, August 2005
By William Allen III and Mary Foster

"The Interaction of Cost Segregation, Code Sec. 1031 Exchanges and Depreciation Recapture" 
Journal of Pass-through Entities, CCH Incorporated, January-February 2004
By Mary Foster & Martin E. Virdick

"Tax-Deferred Exchanges and Cost Segregation:  Benefits and Pitfalls"

2005

By Dr. Mark Lee Levine