Cost Segregation Study Question

[Abad Marroquin]

Hi BP community. I bought 28 apartment units in Georgia in June 2022. I am looking to hire a firm to do a cost segregation study. In one of the quotes, the agents gives me the option wether to authorize the his firm to classify some items under the 5 year instead of 27 yeast, but the IRS has already held in a 2012 case that those items such as cabinets, sinks, etc, are not 5 years, but 27. The agents believes the taxpayer in the 2012 case did not represent themselves appropriately to defend their case. Please let me know what you guys think. I don’t want to be in a situation that I need to be audited by the irs. I am including his exact words here for you to read it.

“For residential properties, please be advised that the IRS may dispute that certain items inside the rental units are not 5-year property. These items include, but are not limited to, certain kitchen cabinetry, kitchen sinks and piping, and appliance related electrical and plumbing systems. On March 12, 2012, the tax court memo involving AmeriSouth XXXII, LTD v. Commissioner held that these components are “structural” and have a 27.5-year tax life. However, it is important to note the taxpayer did not appropriately defend themselves in this case and let the IRS present their positions on these issues without being challenged. Please let us know right away if you do not want us to classify these items to a 5-year tax life”

[Michael Plaks]

@Abad Marroquin

Let's be clear about the audit concept. You are not audited because of cost segregation. The IRS computer does not know if you had cost segregation done. You might be selected because of more general issues, such as very large deductions compared to income or a claim of being a Real Estate Professional. So cost segregation might be part of the game but not THE reason for an audit on its own. 

If you're audited and have a cost segregation report available, you pretty much close the issue. The IRS generally will not challenge professional cost segregation reports. They did in the cited case, however keep in mind that the case was tried before the IRS issued Tangible Property Regulations that changed the game.

What the cost segregation company is (wisely) doing is CYA: shielding themselves from responsibility should, in fact, you be audited. Since they're giving you an option, I'm pretty sure that their audit insurance that @Ashish Acharya alluded to will exclude this particular item, since they feel it is controversial. 

Two pieces of advice:

1. Consult your CPA and gauge their level of comfort with taking this risk.

2. When in doubt - take the risk. You cannot win in business by being risk-averse. (And I just took the risk of posting this, to illustrate.)