Cost segregation and 1031 exchanges: sequence matters

The basis problem

In a like-kind exchange, the replacement property generally takes the relinquished property's adjusted basis plus any additional consideration paid. You do not get a fresh basis equal to the purchase price.

That splits the replacement property into two components for depreciation: exchanged basis, which generally continues on the relinquished property's remaining recovery period and method, and excess basis, which is treated as newly acquired.

What that means for a study

A study on replacement property has to work with both layers. The excess basis behaves like a normal acquisition and is fully available for reclassification and bonus depreciation. The carryover basis is more constrained, continuing the prior schedule unless an election is made to treat the entire basis as newly placed in service.

That election exists under Reg. §1.168(i)-6(i) and is worth modelling, because in a 100% bonus environment it can be the difference between a large first-year deduction and a modest one.

The relinquished property matters too

If the relinquished property had a cost segregation study, section 1245 property in it has its own like-kind matching considerations. Since 2017, like-kind exchange treatment applies only to real property, which means personal property identified in a prior study does not itself qualify for exchange treatment.

Practically this means the 1245 components can generate recapture even inside an exchange, depending on structure and the values involved. It is not a reason to avoid studies on property you might exchange — it is a reason to model it.

Sequence

Bring the study firm in before the exchange closes. Once the replacement property is acquired and the basis allocations are locked in the accounting, options narrow.

The best outcome usually comes from modelling three things together: the study on the replacement property, the election on carryover basis, and the recapture exposure on the relinquished property's 1245 components.

The alternative worth pricing

Some owners find that a taxable sale with a large accelerated deduction on the replacement property nets better than an exchange, particularly where suspended passive losses release on disposition. That is a modelling exercise, not a rule — but it is worth doing before assuming an exchange is automatically correct.