If you are paying for a cost segregation study, you want to receive every dollar allowable. Detailed Engineering Approach studies go through every inch of electrical conduit, every wall mounted door stop, every bolted down bollard to provide the maximum accelerated depreciation. Providers who do not spend the time to examine your property in this level of detail are missing significant value, and are also creating audit hazards for you.
Though there is no such thing as being IRS audit ‘bullet proof’, by using the highest standards set forth by the IRS in its Audit Technique Guide (ATG), you can ensure that the methodology used is favored by the IRS, and that all items are allowed by tax court precedent. Though the IRS Audit Technique Guide does not require any specific methodology, when the ATG states concerns about the validity and accuracy of other methodologies, as a commercial real estate owner, you should avoid them.
How can you recognize a Detailed Engineering Approach in a cost segregation study?
Though there are many steps to a quality, detailed engineering approach, a few items stand out that make this type of study easy to identify.
Does the provider conduct a property tour lasting several hours?
A quality study should photographically document all visible segregated items. ‘Drive by’ studies where a tour lasts for only a few minutes, with limited documentation does not meet this highest standard.
Does the provider prepare line item take offs, such as the image below, tying in all costs to either an invoice, or an approved engineering estimating reference allowed by the IRS?
Does the provider examine all available plans and drawings? Or create working drawings when none exist? Does the provider examine all available cost information from the client, as well as from contractors and subcontractors?
Examination of the details of a project, both from an engineering and cost perspective are required to give you a high quality study.
What cost segregation approaches should be avoided?
Cost segregation is not a commodity. The value is in the quality of the work. Approaches which cut corners decrease the cost to the provider, as well as the fee to the client, but these cost saving measures come at the expense of the client, who is not receiving a quality study.
Cheap poor quality work is the most expensive service you can buy.
Percentage Estimating, sometimes called ‘Rule of Thumb’
If a provider is simply breaking down a building into percentage categories, for example, 30% electrical, this is a clear indication you have received a Rule of Thumb study.
ATG states “An examiner should view this approach with caution, since it lacks sufficient documentation.” Do you want to hire a firm using a methodology that is being viewed with caution?
Sampling or Modeling
This is a method sometimes used when multiple properties of very similar type are owned by the same entity. – An example would be multiple fast food locations of the same franchise.
ATG states “A frequent issue is the accuracy of the sampling results. …despite the fact that facilities within certain strata may appear to be very similar, variations in building codes, geographic location, and material and labor costs may make it difficult to determine an appropriate model.”
Cost Segregation Case Studies
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Do you own commercial real estate (exclusive of land) with a value of $250,000+, or do you own leasehold improvements valued at $100,000+?
Have you owned these assets for less than 15 years?
Will the owning entities owe income taxes this year, or within 3 years?
Do you plan to own the assets for 3 years or more?