Real estate investors often use a 1031 exchange to defer capital gains when selling one property and purchasing another. But a common mistake in calculating the basis can quietly erode the tax benefits of the exchange, according to Brian Kiczula of CostSegRx.
The issue centers on the excess basis—the amount of new investment in the replacement property that can be subject to a cost segregation study. When investors complete a 1031 exchange, they carry forward the depreciation method from the sold property to the new one. This carryover is the existing basis. Only the portion above that—the excess basis representing genuinely new investment—qualifies for cost segregation.
Kiczula, a member of the American Society of Cost Segregation Professionals, sees investors and CPAs frequently make the error of conflating the transferred gain with the remaining depreciable base. “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 explains. “That’s not the right calculation.” Using the wrong number risks disrupting the exchange itself, as accuracy here is critical to preserving the like-kind property status.
Not every 1031 exchange presents a cost segregation opportunity. If investors acquire a replacement property for only slightly more than the sold property, the new basis may be negligible. Paying for a study with little to no excess basis is not worthwhile. “We need to calculate upfront whether there is a benefit for doing a cost segregation study,” Kiczula stresses, “because there’s not always one.”
Coordination between the cost segregation provider and the tax preparer must happen early—before the study begins and before the property is acquired. To assess the benefit properly, the provider needs more than the closing statement and 1031 exchange documents. They require the full fixed asset schedule from the original property, detailing what was depreciated and how, plus a clear understanding of the exchange structure. Without this, any estimate is built on incomplete information.
For investors heading into a 1031 exchange and considering cost segregation, key documents include closing statements from both the sale and acquisition, the 1031 exchange documents showing transferred values, and the fixed asset schedule from the relinquished property. This schedule allows the provider to calculate the carryover basis and determine whether an excess basis exists.
The exchange complicates a standard acquisition, but the core principle remains: get the right numbers to the right people before moving forward. CostSegRx offers complimentary estimates of benefit and collaborates with investors and their CPAs to ensure accuracy from the start. Learn more at costsegrx.com.
