Here is what I am doing for cost segregation of residential rental property, that was placed in service in 2018, applying 100% bonus depreciation to the classes with 20 years or less. The purchase was normal, not from a family member or partner. I fit the "small taxpayer" as defined as having less than $10M in income.
Form 3115:
line 1(a) enter "7" in first box. This is based on Rev. Proc. 2022-14 section 6.01(3)(b)(vii) which provides the statement for “changing the classification of an item of property from § 1250 property to § 1245 property” (ie cost segregation). Page 29 of https://www.irs.gov/pub/irs-drop/rp-22-14.pdf
6.01(5) – (7) of Page 30-31 give more details on the 481 adjustment and basis calculation, which is what I used part of the guidelines I used for the 481(a) calculation.
3115 line 25: no
3115 line 26: This is the catch up depreciation, which is a decrease to income, so is a negative number. Catch up depreciation calculation: Calculate the new total depreciation from the start up to the current year, which is the full bonus depreciation of the 5-20 year classes, plus the 27.5 S/L depreciation of the reclassified 27.5 year property (from start to current year). Then subtract the accumulated depreciation that had been taken for the property on prior tax return. Enter as a negative number.
3115 line 27: no
3115 line 28: N/A. The instructions for the line indicate that this only applies to positive adjustments. We are making a negative adjustment. To be further certain I read what it points to, which is section 7.03(3)(c) of Rev. Proc. 2015-13, which states “the § 481(a) adjustment period is one taxable year (year of change) for a negative § 481(a) adjustment and four taxable years (year of change and next three taxable years) for a positive § 481(a) adjustment.” and goes on to talk about the election to take a positive adjustment in 1 year instead of 4.
3115 line 29: no
Hopefully the tax software will carry the 481(a) adjustment correctly into the return.
Form 4562:
Because the basis of the 27.5 property has been reduced due to the splitting, form 4562 must be adjusted, so that the software will calculate the correct 27.5 S/L depreciation in future years. Edit form 4562 (rental income) and change the basis to the new 27.5 year basis based on cost seg. Changed the "prior depreciation" to the re-calculated 27.5 S/L for the new basis.
So the basis of the 5-20 year property is not longer included anywhere in the software. That does not seem good. To capture it, I added an additional 4562 described as "rental xxx cost seg section 1245 property". In service date is same as the rental prop. I used "other" for the property class in order to lump all of them together rather than create a 4562 for each property class type. Used total basis for the bonus depreciated classes. I set the prior 100% bonus depreciation to match the basis. The net effect is to record the basis and depreciation, but there is no depreciation added from that 4562 in the current or future years.
I attached a sheet stating that I am using form 3115 to adjust my method of accounting based on a cost segregation for section 1250 to section 1245 re-classification. I included the long statement for “changing the classification of an item of property from § 1250 property to § 1245 property” from page 29 of https://www.irs.gov/pub/irs-drop/rp-22-14.pdf
I included my calculations for the catch up basis adjustment value of 481(a).
I included the cost seg report.
I have another property where I am doing a 1031 exchange and cost segmentation in the same year.
To get the max value of the cost seg, I will to take the election of "section 168(i)-6(i)" on form 4562 to treat the exchanged basis as placed in service in the year of exchange. The new property basis will be the remaining basis of the sold property plus the "excess basis" (which is the new purchase price minus the new land value minus the sales price of the old). This new basis can then be cost segregated. I plan to create a 4562 for each class of property, applying 80% bonus depreciation to the 5-20 year property with the remaining 20% depreciated in future.
