Four Ways to Ensure the IRS Accepts Your Cost Segregation Study

Written by Darren Labrie, CPA. Updated Apr 30, 2019.

StudyingBook Reports. Back in school, many of us agonized over the time-consuming, rule-laden amalgamation of facts and theories. Sometimes you were permitted to pick the topic, sometimes the teacher did. But the teacher always laid down the requirements: double-spaced; 800 to 1,000 words; typed (or printed if you go back that far); include a cover page with your name, date, etc.

And if you blundered the directions, points were knocked off your grade; miss too many and you risked a failing grade. Flash-forward to adulthood, tax liability, and cost segregation studies. Unlike dreaded school reports, cost segregation studies are not a required task. Yet a CPA’s client businesses will want to reap the benefits of the studies – as the IRS describes, cost segregation is the most preferred method for accurately measuring and classifying lump sum costs for depreciation purposes, and is ultimately a viable tax-saving opportunity.

 Why Should a Professional Handle Your Cost Segregation Study?

However, much like a scrupulous school teacher, the IRS imposes strict quality standards for cost segregation approval. Fail to meet these principal elements, and the IRS may deny your study and the tax saving benefits it’s intended to deliver.

With significant savings at stake, every precaution should be taken to ensure your study passes the IRS’ rules, regulations, and scrutinizing eyes. With just one mistake, one missing piece of information or misinformation, the IRS penalty incurred could ruin client relationships and damage a CPA’s reputation.

Review the following four ways to help you secure a quality, IRS-acceptable analysis:

4 Tips to ‘Make the Grade’ on Your Cost Segregation Study

1. Don’t Forget the Cost Segregation Audit Techniques Guide (ATG)
Don’t conduct your cost segregation study without it. The IRS developed the ATG to direct examiners in study reviews. It stands to provide three primary guide points:
  • Why organizations perform cost segregation studies for federal tax purposes
  • How cost segregation studies are prepared
  • What to look for in the review process

Someone who knows the ATG stands as your best ally when conducting your study.

2. Don’t Take Shortcuts
History is riddled with true and fabled tales of the dangers of cutting corners. Trying to find the easier or shorter way around a process usually ends with the opposite effect. If the IRS audits your study and finds you’ve skirted details, they may refuse some or all of your intended deductions.

One universally common shortcut many firms take: failing to take documentation photos of a subject property’s building and surrounding land. The IRS views studies lacking photographic evidence as substandard.

But any corner cutting can warrant the IRS to deny your cost segregation study. Follow their preconditions precisely to reinforce your chances of approval.

3. Properly Categorize Subject Property
Different types of facilities fall into different categories. An office building is categorized differently than a manufacturing facility. The IRS reviews the reclassification percentage to determine if they fall into the industry standard. They will also examine subcategories of costs and look for inaccurate or improperly classified assets.

A more conservative approach is recommended for those industries that tend towards more aggressive facility categorization. The MACRS (Modified Accelerated Cost Recovery System) helps to determine depreciation for your property and your property’s recovery class.

4. Adhere to IRS Form 3115 Filing Rules
Businesses performing cost segregation studies for properties owned two or more years are required to file at least one 3115 for its federal tax return. Form 3115 harbors complexities that may lead to errors if not thoroughly understood.

During the year in which a tangible property is placed in service, an accounting method is adopted relative to the depreciation method, recovery period, or convention for the depreciable property.

If you have depreciated an existing building in prior years, then a request must be made to the IRS to change the accounting method that was previously used for the building.

But this foreboding form alone has deterred organizations from pursuing cost segregation studies. The IRS estimates Form 3115 requires 60 hours to fully complete and file properly. With that level of complexity and time consumption, partnering with a cost segregation expert can help alleviate frustration, confusion, and chances of denial.

Ensure Your Study Passes the IRS Test

The IRS scrutinizes cost segregation studies for incomplete or incorrect information. And section 6662 of the tax code underscores the need for total accuracy: the negligence penalty is 20% of the underpayment in tax.

If your CPAs are not guiding clients on available cost segregation opportunities with accurate and properly rendered cost segregation studies, your clients are missing out on substantial credits and incentives. Make certain you’re delivering maximum tax-savings to your clients by partnering with a tax specialist.



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Topics: Cost Segregation

Darren Labrie, CPA

Written by Darren Labrie, CPA

Darren brings more than 20 years of experience in tax credits and business incentives. In his current role, he focuses on the overall operations of the practice and ensuring the highest level of service to clients.