Cost Segregation in 1031 Exchanges: Why Getting the Basis Wrong Can Undermine Tax Benefits

Real estate investors know a 1031 exchange lets them defer capital gains when selling one property and rolling the proceeds into another. What fewer understand is how cost segregation fits into that transaction, and the specific mistake that can quietly undermine the tax benefit before the ink dries on the new purchase.

According to Brian Kiczula of CostSegRx, the problem almost always comes down to one thing: not correctly identifying the excess basis.

The Basis Calculation Most Investors Get Wrong

When you do a 1031 exchange, you carry forward the depreciation method from the relinquished property into the replacement property. That carryover is your existing basis. Typically, the only portion you can run a cost segregation study on is what sits above that, the excess basis, which represents genuinely new investment in the property.

The mistake Kiczula sees regularly is investors, and sometimes their CPAs, conflating the gain that transferred over with what remains as a new 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 says. “That’s not the right calculation.”

If you use the wrong number, you risk disrupting the exchange itself. Since you’re trading like-kind property, accuracy here is not just about getting more depreciation. It’s about not jeopardizing the 1031 altogether.

When Cost Segregation on a 1031 Property Does Not Make Sense

Not every 1031 exchange creates an opportunity for a cost segregation study. If you sold a property and acquired a replacement for only slightly more, the actual new basis in that property may be negligible. Paying for a study when there is little to no excess basis is simply not worth it.

This is why Kiczula stresses doing the math before engaging. “We need to calculate upfront whether there is a benefit for doing a cost segregation study,” he says. “Because there’s not always one.”

The Cost Seg Provider and CPA Need to Work Together Before You Close

One of the more overlooked points about 1031 exchanges is that collaboration between your cost segregation professional and your tax preparer needs to happen early. Not after the study is done. Not after the property is acquired. Before the engagement begins.

To do the work properly, the cost segregation provider needs more than just a closing statement and the 1031 exchange documents. They need the full fixed asset schedule from the original property, showing what was already being depreciated and how, plus a clear picture of how the exchange was structured. Without all of that, any estimate of benefit is built on incomplete information.

What to Send Your Cost Segregation Provider After a 1031

If you’re heading into a 1031 exchange and plan to explore cost segregation on the replacement property, the documentation that matters most includes the closing statement from both the sale and the acquisition, the 1031 exchange documents showing what was transferred, and the fixed asset schedule from the relinquished property. That schedule is what allows your cost seg provider to properly calculate the carryover basis and determine whether an excess basis even exists.

The exchange is often the more complicated version of a standard acquisition. But the core principle is the same: get the right numbers in front of the right people before moving forward.

CostSegRx provides complimentary estimates of benefit and works alongside investors and their CPAs to make sure the numbers are right from the start.