There are many myths surrounding cost segregation and its benefits.
There are many myths surrounding cost segregation and its benefits. The truths behind those myths are discussed below, as well as some answers to very important questions.
Myths:
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The IRS prefers one method to another
There are no real standards for a cost segregation study
A CPA cannot really provide a cost segregation study; you need a "professional".
Myth: The IRS prefers one method for valuation to another.
The IRS has identified six methods for providing cost segregation services, each having its pluses and minuses. More important is that the IRS does not endorse or favor one method over the other. According to the IRS Audit Techniques Guide:
Neither the Service nor any group or association of practitioners has established any requirements or standards for the preparation of cost segregation studies. The courts have addressed component depreciation, but have not specifically addressed the methodologies of cost segregation studies.
The Service has addressed this issue but only briefly, i.e., Revenue Ruling 73-410, 1973-2 C.B. 53, Private Letter Ruling (PLR) 7941002 (June 25, 1979), Chief Counsel Advice Memorandum 199921045 (April 1, 1999). These documents all emphasize that the determination of § 1245 property is factually intensive and must be supported by corroborating evidence. In addition, an underlying assumption is that the study is performed by "qualified" individuals or firms, such as those employing "…personnel competent in design, construction, auditing, and estimating procedures relating to building construction" (PLR 7941002).
The six IRS-approved methods are: - Detailed engineering approach from actual cost records
- Detailed engineering cost estimate approach
- Survey or letter approach
- Residual estimation approach
- Sampling or modeling approach
- "Rule of thumb" approach
Each of these methods is acceptable and each has been and will be used by tax payers to do cost segregation studies. All six approaches, or blended versions of them, are acceptable to the IRS. No one method is favored.
Myth: There are no real standards for a Cost Segregation Study.
The IRS has established a set of guidelines that define what they call a "quality study." The definition of a "quality study" is one that addresses each of the 13 elements listed below. - Preparation by an individual with expertise and experience
- Detailed description of the methodology
- Use of appropriate documentation
- Interviews conducted with appropriate parties
- Use of a common nomenclature
- Use of a standard numbering system
- Explanation of the legal analysis
- Determination of unit costs and engineering "take-offs"
- Organization of assets into lists or groups
- Reconciliation of total allocated costs to total actual costs
- Explanation of the treatment of indirect costs
- Identification and listing of section 1245 property
- Consideration of related aspects (e.g., IRC § 263A, Change In Accounting Method and Sampling Techniques)
Myth: A CPA cannot really provide a Cost Segregation Study, you need a "professional".
This myth clearly assumes CPAs lack the expertise to perform cost segregation analyses. Especially on new construction, where there are good cost records, a knowledgeable CPA can do a more than acceptable job in preparing a cost segregation study. With proper cost records, a CPA can effectively and professionally complete an engineering-type study using cost records. In many cases, we find ourselves assisting a CPA, not by providing the valuation, but by helping to assign lives of assets and assuring that the assets are properly allocated.
Cost Segregation Myths
