Real estate investors often turn to 1031 exchanges to defer capital gains when selling one property and reinvesting the proceeds into another. However, a common mistake involving cost segregation can quietly undermine the tax benefit, according to Brian Kiczula of CostSegRx, an engineering-based cost segregation firm.
The core issue lies in incorrectly calculating the excess basis. In a 1031 exchange, the depreciation method from the relinquished property carries forward to the replacement property, forming the carryover basis. A cost segregation study can only be applied to the excess basis—the portion representing genuinely new investment. Kiczula notes that investors and even CPAs sometimes conflate the transferred gain with the new depreciable base, leading to an incorrect calculation. “A lot of times they’ll simply take the gain that was transferred onto the new property and assume that once you take out that gain, the excess basis is the remainder,” he says. “That’s not the right calculation.” Using the wrong number risks disrupting the exchange itself, as accuracy is essential for maintaining like-kind property status.
Not every 1031 exchange presents an opportunity for cost segregation. If the replacement property is acquired for only slightly more than the relinquished property, the new basis may be negligible, making a study not worth the cost. Kiczula emphasizes doing the math upfront: “We need to calculate upfront whether there is a benefit for doing a cost segregation study. Because there’s not always one.”
Collaboration between the cost segregation provider and the CPA must occur early—before closing. The provider needs more than just the closing statement and exchange documents; they require the full fixed asset schedule from the original property, showing how assets were depreciated, and a clear picture of the exchange structure. Without this, any benefit estimate is built on incomplete information.
For investors heading into a 1031 exchange, key documentation includes the closing statements for both the sale and acquisition, the 1031 exchange documents, and the fixed asset schedule from the relinquished property. This allows the cost segregation provider to properly calculate the carryover basis and determine if an excess basis exists.
CostSegRx, led by Brian Kiczula, a member of the American Society of Cost Segregation Professionals, provides complimentary estimates of benefit and works alongside investors and their CPAs nationwide. For more information, visit costsegrx.com.
