How can you make sure you get the benefits of your cost segregation study without putting yourself at risk if you get audited some years in the future?
Owners of commercial real estate and apartments can benefit greatly from cost segregation services, reducing their income tax liability and increasing their cash flow. But what happens if you are audited?
First, make sure you avoid the temptation to do your own cost segregation study. Nor should you have your accountant cost-segregate your property. Those would raise red flags with the IRS, which prefers to see that cost segregation studies have been performed by qualified specialists. Cost segregation studies should reflect an engineering-based approach, containing many specific types of data, analysis and references to relevant tax law supporting the study’s conclusions.
The cost of having a professionally-prepared study prepared by a qualified provider is usually low enough that it will generate more than enough additional tax benefit to justify paying a fee, and also will protect the property owner in the event of an audit. As discussed below, the IRS looks favorably upon studies that have been prepared by qualified practitioners, with their cost segregation credentials included within the report. When that element is missing, the IRS would have a reason to start digging deeper rather than say “OK, looks good.”
Cost segregation providers are not all the same. You need to consider their experience and expertise, and whether they use a true, engineering-based method that will stand up to IRS scrutiny. Preferably, the engineers performing the study are members of the American Society of Cost Segregation Professionals, which provides some assurance as to their level of professional qualifications.
Make sure the cost segregation firm you choose will perform a detailed on-site review of your property, as expected by the IRS, as well as reviewing your building plans and cost records, if available. Cost segregation studies should not rely on a desk review only.
Cost segregation makes use of complex tax laws, regulations and legal precedents, which change over time. Be sure your cost segregation provider has in-house tax experts that keep up with this particular niche of tax practice.
The chances of being audited by the IRS are always small but not zero. A cost segregation study, by itself, does not increase the chances of an audit. If you are selected for an audit for some other reason, it’s possible that your cost segregation study, and your depreciation deductions, could be scrutinized the IRS. If that happens you will be glad if you selected a provider that is still around, and even more glad if they provided assurances – in writing – that your study is backed by a credible form of audit defense. That means that the provider will send their engineer to talk with the IRS agent and defend their work if needed. Even better if they will commit to doing so at no additional cost to you.
There is no standard price structure for cost segregation studies. Unlike other “tax recovery” services, in the cost segregation industry there is a tendency to avoid performance-based fees and instead fees are fixed in advance based or figured according to time and materials cost. The IRS specifically states in their Audit Techniques Guide for Cost Segregation that, “examiners should closely scrutinize studies performed on contingency fees.”
Stay away from a contingency fee arrangement. It creates an incentive for the cost segregation provider to be overly aggressive and utilize inappropriate estimating techniques. Most reputable cost segregation providers work on a fixed fee basis.
If you are audited by the IRS, and the cost segregation study is brought within its scope, you or your CPA should immediately contact the firm that prepared the study for assistance. If they provided a written commitment to defend the study in the event of an audit, you can expect them to respond by requesting information about the audit, then they will prepare to review the report with the examiner and defend the study.
You and your cost segregation provider are highly likely to prevail in the event of a challenge by the IRS if the cost segregation study was properly prepared. The best way to ensure that this was done is to select a firm that adheres both the standards of the industry association (the ASCSP) and the definition of a “quality study” as detailed in the IRS Audit Techniques Guide for Cost Segregation.
If you want the highest level of assurance that your study will not be challenged if an audit takes place, call a reputable cost segregation firm that has tax experts and engineers on staff, preferably engineers that are not only experienced in construction engineering and cost estimation but also are certified members of the industry association, the American Society of Cost Segregation Professionals.
Read The Complete Cost Segregation Study Buyers Guide — it’ll give you the knowledge you need to ask the right questions and make a sound decision when it’s time to pick (or change) providers. Read this guide to obtain the benefits of cost segregation with the least time, effort, worry and cost.
In this guide, you’ll learn:
Then, contact me for a complimentary consultation and estimation of benefits.
Jeff helps real estate owners increase their cash flow. He started his career as a Financial Analyst with the Irvine Company, and worked in various management/executive positions in the mortgage industry for many years. He's been a Cost Segregation consultant for several years and is considered one of the industry's top experts in TPRs. As Director of Business Development for Bedford Cost Segregation, Jeff helps his clients increase cash flow by accelerating their depreciation deductions, and by writing off assets that no longer need to be depreciated under recently changed tax rules. Jeff has a B.S. in Economics from Claremont McKenna College and an MBA with an emphasis in Finance from UC Berkeley.
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