Former IRS Agent Reveals Cost Segregation Audit Red Flags + 1031 Exchange Basis & Bonus Depreciation Rules

SPEAKER_00 0:07

Welcome back to another episode of the Real Estate Explainer podcast. I am your host, Brian Kixula, a cost segregation specialist with CostSeg RX. Today we've got Victoria Boone on the podcast. She is a former IRS senior revenue agent and subject matter expert. Let's jump right into the episode. Victoria, thanks for jumping on the podcast today. I am very happy to have you here.

SPEAKER_01 0:34

Thanks for having me. I'm excited to be here. I spent 22 years at the IRS where I did everything from when people go to the walk-in and ask questions to I audited small business returns, I audited large business returns. And then for five years, I was a subject matter expert in deductible in capital expenditures. So if it didn't kind of fit in a nice neat category somewhere else, that's what we focused in on. So I did a lot of things such as meals and entertainment, charitable contributions, fines and penalties, cost segregation, 1031, depreciation, intangible stuff. There's a lot of variety of different things that I was a subject matter expert in. And last year I left the IRS in October as part of the Doge program and deferred resignation and started my own company. I have two companies now. One is a consulting company called Boom Tax Group. No E. Their website's boom.tax, and I do consulting and also work with my husband who helps people who have tax issues. So they might owe the IRS and has liens or levies and things like that. But we help with that, as well as consulting, as far as there's a 1031 exchange, there's a cost segregation, there's aircraft. It's another area that I was on my campaign for. So that's the first company. And then I also have an education company called Boone Tax Educators. And we provide continuing education on different tax topics. So we dig into different topics. I have former IRS personnel that come in and present on the platform. And we have some great information that's out there. It's meant for enrolled agents and CPAs, but it's also beneficial just for CFOs or those that are interested in a specific tax topic that is pertinent to their industry or where they're working right now. So I have taught a class, for example, on cost segregation and had a former IRS engineer come in and taught that class with me. We have classes on 1031 exchanges. We have one on partial dispositions, which I think would be really interesting for real estate and in your audience. So we have a lot of great topics there. And also right now, there should be my book will be released shortly. I'm not sure exactly when it's going to be published, but it's called Before the Close. And it is geared towards real estate agents, and it covers all these different topics that might come up in a real estate transaction, whether it be such as fraud alerts, liens, levies. It could be deductibility of mortgage points. It covers cost segregation, 1031 exchanges. It covers Augusta rule, reps. So it's going to cover a lot of different topics on a very high level, just so that real estate agents and mortgage lenders and brokers can really understand the transactions, be a benefit to their clients. And they can say, okay, it might benefit you to contact a tax professional about this topic. I'm not trying to provide tax advice. Real estate agents shouldn't be providing tax advice, but at the least they can say, hey, we can make this transaction even better for you if you implement some tax strategies and go look into the strategies because you can't even suggest them if you don't know what they are or how they interact.

SPEAKER_00 4:01

So it's certainly been a busy year to say the least. And that's how we met was through the American Society of Cost Segregation Professionals. We recorded internal video for them. And then I subsequently had signed up and taken a couple of your classes, and they do add a tremendous amount of value. I took one on cost segregation. I've done another one on partial asset dispositions. And I see your emails that come across, and I'm definitely excited to continue taking more of them because it's certainly topics that I touch on every day. And that's selfishly what I wanted to talk about is specifically as a subject matter expert. Can you address some common issues that you see with cost segregation studies? And some of the things that I'm talking about are items such as the basis of the property, land allocations, and then the different approaches when you're doing a cost segregation study.

SPEAKER_01 5:02

So if there is a cost segregation study that's audited, I'll just start off by explaining how the process works. And so to see exactly where I fit in. So the process works is the revenue agent or auditor is assigned the case and they say, I want to look at the cost segregation. And when they do that, they usually do two things. One, they're going to look at the report and they're going to request and ask questions about that. And then they're going to also request an engineer. I'm not an engineer, but I did work with a lot of the engineers and they're great people, but they dig into a lot of the reports in the items about that. And they can also ask for a subject matter expert, which is where I would come in. So I would see a lot of these cost segregations reports that would come in and they would say, okay, what do I do? There's a cost segregation report. Is it good? Is there something that I should look at? Things like that. And there's a few things that always stand out. And you had mentioned land value. That's a huge issue. A lot of times the cost segregation reports will not say that, assuming this is much as land, they won't address land value at all. They'll just take the whole purchase price and allocate it towards either $1,245 or $12.50 property. And that's an easy thing to reconcile. Even as an auditor, they can say, hey, look, there's no mention of land value. There's no allocation of land value. That's an easy thing for them to fix and adjust, even without getting an engineer in and going and deep dive into all the reports and making sure all of that is right. Land value is an easy one that auditors pick up on because it has to be addressed. It either has to say, here's how much is land, or here's the purchase price minus land, and here's how we're going to allocate it. But not even mentioning land at all is where we would see when there were adjustments.

SPEAKER_00 6:55

Like you said, it's an easy thing to call out. So when you're looking at a report, you may see depreciable basis, but the revenue agent most likely doesn't have the closing statement, the work papers, or any of the supporting documents. So at the minimum, I'd imagine when they're looking at a cost segregation report, they want to see the cost basis, the land allocation, which is a non-depreciable asset, and then the basis for cost segregation. And I've seen a number of reports that miss that as well. They just go straight to basis. And for an auditor revenue agent, I can see how that would trigger, hey, well, we need to at least deduct for the land.

SPEAKER_01 7:34

So that is like an easy one. Others that you would look at is estimates. When you're looking at the estimates in the reports, you can see there will be like a multiplier. Okay, we think that here's this, and then we have to multiply it by a number in order to get it up to the value that we're going to allocate. And usually that indicates that there was something missed in the analysis somewhere. Because why would you need a multiplier? There should be a reasonable basis for these estimates. They shouldn't just be a multiplier. And that's another thing that is easily caught and easily looked at is any kind of multiplier.

SPEAKER_00 8:10

So one of the things as a cost segregation specialist, I definitely see the disconnect a lot of times because you might be looking at the cost of the roof. The material and labor are certainly one cost, but you're also going to have the indirect cost that need to be factored into the cost segregation study. And I can see that's where a multiplier would have to come into play. And so indirect costs definitely need to be addressed in the study itself.

SPEAKER_01 8:36

If you're saying, well, we're going to take this and we're going to inch it up a little bit, that's one thing. But I mean, I've seen reports that would get flagged for audit where the multiplier is times six. And you're going, something's not right here when that multiplier is that high. So I'm not saying that there is a specific number that, you know, anything over this number or under this number is valid, but it kind of has to pass the SNF test. It has to make sense given the facts and circumstances.

SPEAKER_00 9:05

So then looking at the different approaches, is that another red flag that pops up when you're auditing or looking at it from the IRS's perspective?

SPEAKER_01 9:15

A lot of times the cost tag reports tend to focus on here's what the 1245 property is. And they go very into a lot of detail on what makes up the 1245 property and the costs associated, but not as much effort is put into the 1245 side. So you have kind of a lopsided report sometimes where you'll see a whole bunch of detail of the 1245. And then you're looking at something that's 1250 property and you're going, well, what about the rebar that goes into that concrete? And what about the other items that go into that? Sometimes you can tell that there's a disconnect between the focus of the cost being allocated.

SPEAKER_00 9:56

And what we're talking about is when you're looking at doing a cost segregation study on a property, you're going to have the cost basis less the land allocation, which is non-depreciable. Then we're going to go in and we're going to look at, as a cost segregation specialist, we're going to look at your 1245 property, which is your personal property, versus your 1250 property, which is your real property. The difference is a 1245 property is typically a short life asset, something five years, 15 years or less, or 20 years or less, really. And then your 1250 property needs to be depreciated over 27 and a half or 39 years. And what Victoria is saying is they'll list out all the carpet and short life assets, but then they'll lump everything else as one item, the structure, and not really break it down into its individual cost components. And if you've ever built a house or if you've ever built a commercial building, you know that there is a lot of cost in building and there's a lot of 1250 property involved.

SPEAKER_01 10:59

I think that's the main issues that I've seen that are like just glaring. You can go into the reports and get technical and different things like that. But I think that those are really the big red flags for me as an auditor. If those things are addressed, then I'm not necessarily gonna go dig into all of the little nitty-gritty classification of assets.

SPEAKER_00 11:24

I'd like to thank today's sponsor, CostSegRX, a cost segregation company. If you're interested in getting a cost segregation study, or if you'd like a free estimate, a benefit, log on to realestateexplainer.com and click the cost segregation link at the top of the page. So one of the things that I certainly see or I tell my team is that, you know, I always say, when we're doing these reports, assume that 100% of the reports are gonna be audited in the future. And my thought is, you know, AI is here. It is coming. The IRS I know is gonna be implementing it. It's probably gonna take them a couple of years, but once they do implement it, everything's gonna get audited. So you have to be prepared to answer the questions when you're segregating those assets. We'll just say I get pushback on sometimes is the percentages or the allocations that I'm using for short life assets. And my thought is just like you said a few minutes ago, it needs to pass the sniff test. And if all of a sudden you've got a property or a garden style apartment complex and you're saying that 35 or 40% of the basis is short life assets, my thought is it's most likely going to trigger an audit at some point because if you don't have those site improvements to really justify the increased 15-year assets, how much are you really having on interior personal property or five-year assets? So, you know, that's kind of my approach on it. Assume that everything's gonna get audited at some point in the future.

SPEAKER_01 13:04

The reality is not a lot get audited. That's just the reality. You can look at the statistics, but it's less than a 1% get audited. If you end up in that 1%, I can tell you that the IRS will say, okay, you did a cost seg on this property. You also have three other businesses and you did cost sags in those businesses. So now we're going to pick up those businesses. So now the ones that are being audited, it's not just oh, one little tiny issue being audited. It's now expanding and it's kind of growing exponentially. You can play the audit lottery and you might win. You might all of a sudden get a letter and it's like, okay, you're being audited. That audit may end up just growing exponentially. So the best thing to do is to be prepared to make sure that you understand, even if you're paying for a cost seg report, that you understand what this cost seg report does? How's it gonna benefit me? If I need to explain this to someone else, how do I explain it? Because it's not useful to you if you don't understand how to use it. It's just a piece of paper. And then you have to try to explain it and you're going, I don't know, just go talk to someone else. That's not gonna help you in an audit. You don't have to know all the details on how every little number was contrived in the report, but you have to understand the premise of the report. You have to understand what is it doing? How is it benefiting me? Because if I don't know how it's benefiting me, what am I paying for? Right. You need to understand that when you're going in, that it's beneficial to me and this is why it's beneficial.

SPEAKER_00 14:39

And that's a big piece of it that we talked to our clients about, you know, on the front end is getting the estimate of benefit, really looking at can you use the depreciation that we're providing to offset either active or passive income? Because if you're truly trying to offset active income, but you can't use it to offset active income, then it may not have a benefit. So I would say get the free estimate of benefit, take it back to your tax preparer, have them review it. And then if it works for your situation, then absolutely move forward. But don't rush into it because you may not need it. And then it's also having the conversation about what are you really planning on doing with that property long term? Are you holding the property? Are you planning on selling it next year? It's more inventory than it is a real estate investment that you're holding for, you know, five or 10 years because you have to look at depreciation recapture, and that's absolutely real. And that's a conversation that you want to have on the front end as well. So I think making sure that it adds value. I do want to transition the conversation a little bit because this is something that I see pop up all the time, and it kind of sneaks in sometimes, and we don't notice it until we're engaged with the client we're moving forward. And that's working with the property that's been involved in a 1031 exchange. A lot of times what we ask for clients, especially when it's a look back study. So for a property that was placed into service in a prior tax year, they're coming to us and say, hey, will you do a cost segregation study on this property? And the answer is yes. Will you provide us a copy of your depreciation schedule so we can see how much you've already taken? So based on that, we'll work up an estimated benefit. But what sometimes happens is we don't realize that that property was acquired using a 1031 exchange. And the issue there is we don't know if there's any basis or excess basis available to do the study on. Can you talk about 1031 exchanges? And I know I actually think I was on one of your courses regarding 1031 exchanges as well.

SPEAKER_01 16:47

Yeah. So with O LiteCon Exchange, essentially the additional funds that you put in, which is excess basis, that amount is the only amount that's eligible for any kind of bonus depreciation. So if you sell real property and replace it with real property, you don't have to pay taxes on the game. That's deferred until that second property is sold. It's really tricky when it gets into depreciation because any carryover amount. So say I had a property and my basis was $100,000, then that basis carries over to the new property. I can depreciate that $100,000. Whether it's made up of $1245, $1250, it doesn't matter. I can depreciate that basis. It carries over. But I can't take bonus depreciation because bonus depreciation is essentially only available for new assets. This isn't considered a new asset because it's a carryover from the other asset. So I can only do bonus depreciation for any excess basis, meaning any additional funds that I put in. So that could be loans, it could be gains that were recognized, it could be a lot of different things. That gets missed a lot with like count exchanges. I will say that was my area of expertise at the IRS. All the publications and the instructions and the forms have been updated for the first time in 15 years. So if you have not looked at the publications recently, I would highly suggest looking at them because they have all been updated and there's additional information and guidance in there. But what gets missed is the difference between excess and carryover basis, because at any other time, basis is basis, right? You just take this amount and you depreciate it. That's not quite the case with Litecount exchanges. When there's a cost seg plus a LiteCon exchange, you have to have a coordination between a tax advisor and the cost seg people. Because what will happen is first you do the cost seg and it says, here's the fair market value of all these different assets. Then the tax professional goes in and says, okay, I'm going to go and identify if any of these are like kind or non-like kind property. And there might be a partial gain that has to be recognized for any non-like kind. So they have to take that information from the cost side report, run it through their gain calculation. And now they can give you basis. They can give you carryover basis and excess basis. That goes back to the cost side people. The cost side people can then allocate that out and between all the different types of property, and they can say, here's your new depreciation schedule. But most of the time that gets missed because there's a lot of coordination that has to happen during that whole process of everything that goes on.

SPEAKER_00 19:25

And the challenge that we see as cost segregation specialists is a lot of times we're getting these transactions at the very last minute. Same thing with their CPA. They may be sitting down to do your taxes. You've gathered all your work papers, you've made your appointment to meet with your CPA or tax preparer. You have to file on the 15th or whatever your filing deadline is. And you kind of have that hour to do everything. And if you haven't worked out those numbers ahead of time, then it just stops the process. So when you're working with cost segregation studies and you're working with 1031 exchanges, I absolutely recommend working with a tax professional that you can meet with on a regular basis. So you let them know, hey, I did a 1031 exchange on this property. I'm acquiring another property. Don't wait until your annual meeting, right before you file those taxes, to really crunch the numbers. You need to do it ahead of time because sometimes the numbers get very complicated, especially if there was other transactions before that initial transaction. And we see that a lot of times too. So we just want to make sure, as you know, cost segregation specialists, that once we do the cost segregation study, not only can we defend the study itself, but we can help defend the basis in the way it was calculated. Because that's some of the common issues. That's going to be one of the first things that fails is how did you calculate that basis? So it kind of circles back. And I know that you had an instrumental part of helping publish, such as IRS Publication 946, IRS Publication 551. Those publications are documents that both tax professionals across the country and cost segregation professionals definitely go back to all the time. So definitely appreciate everything that you do. Before we wrap up the podcast, I would like to talk a little bit more about some of the classes that you offer. If you could just list a few of the courses that you teach and then the best way to access those courses or reach out to you directly.

SPEAKER_01 21:33

We have a lot of different topics that we cover. We have covered charitable contributions and deductibility of meals and entertainment. We've done 1031, COSEG, Partial Dispositions. We're doing one that name, image, and likeness of college athletes. We're doing one on the new education credits that start next year. So that should be interesting. So we have a wide variety of different topics. We'll have one on ethics and AI, penalty abatement. So there's a lot of things, even unpaid payroll taxes and how that can control be a ticking time bomb, as they call it. What people don't realize is that payroll taxes have to be paid. And if they're not paid by the company, they can go after the designated officials. So that is something that we cover in one of our classes. So you can go to our website, www.boone taxeducators.com. You can see all the classes. We have live webinars and we also have self-study. If you prefer you want to reach out to me directly, you can email me at victoria at boon.tax. Remember, there's no e in boon. Feel free to reach out. And I will say, as far as contacting your tax advisor, do it before you even think about doing a COFSAG or a 1031 exchange, because the more time they have to advise you, the more helpful they can be and to help you get to your goals.

SPEAKER_00 23:00

And that ties right back into the book that you just put out before the close. So that's the perfect name for the book that you've got coming out. Well, thank you very much for joining us on the podcast, and I look forward to talking to you real soon.

SPEAKER_01 23:13

Thank you for having me.