Cost Seg Applied by Non-Engineers Equally Acceptable by the IRS
While it is a commonly held belief that cost segregation studies need be administered and executed by an engineer, the reasoning behind this opinion is actually faulty.
Cost segregation studies that were mainly produced for commercial property owners are held to an at-best sketchy legal precedent as to what is personal (1245) property and what is 1250 (real) property. Making the distinction between the two can sometimes be challenging due to the nature of complex buildings with nuanced and specialized architecture. This difficulty led to an unfounded belief that the only valid cost seg study should come from and engineer.
Never mind that the cost for engineered cost segregation studies can begin at $15,000.
Residential Cost Seg Studies
But in residential cost segregation studies, all that is dealt with is personal property, as it is described by the IRS. There is no messy distinction-making involved. The personal property is valued, and this third-party valuation is enough to qualify a taxpayer for accelerated depreciation (more cash flow). So not only do you not need an engineer for a residential cost seg study, but it is questionable whether you need an actual engineer for a commercial cost seg as well.
Here is an excerpt from the IRS’ ATG (Audit Technique Guide):
WHAT METHODOLOGY IS REQUIRED BY THE IRS?
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).
Despite the lack of specific requirements for preparing cost segregation studies, taxpayers still must substantiate their depreciation deductions and classifications of property. Substantiation using actual costs is generally preferable to the use of estimates. However, in situations where estimation is the only option, the methodology and the source of any cost data should be clearly documented. In addition, estimated costs should be reconciled back to actual costs or purchase price.
Setting the Standard in Residential Cost Segregation
So it is we find that our rigorous 3-day on-site training is certainly enough qualification to handle the valuation of personal property. Shamefully, we do not know of many other companies that take the time and commit the expense to thoroughly train and educate their evaluators/appraisers.
Our evaluators participate in ongoing educational outreach to investors and are continuously in front of CPAs and their clients, Real Estate Agents and Investors, teaching about the benefits of chattel and learning about the investor’s trials and tribulations. We are always supplying them with the lastest resources that will keep them abreast of what’s happening in their market. Plus, in ongoing conversations with CPAs, they continue to further refine and expand their general tax knowledge base.
For a complete list of thoroughly trained and supported Field Appraisers throughout the US, find your geographical location on the BlogRoll to the right. These Appraisers are trained with the knowledge and work with the support to effortlessly maximize the cash flow on your residential real estate investments. Their costing company is second-to-none, and is actually cited in the IRS ATG as a standard.
Due Diligence
When employing someone to do your residential cost seg study, always check that they carry general liabiloity insurance as well as E & O Insurance. Double check where they received their training, and their source of the costing data. These key indicators will readily demonstrate the calibur of appraiser with which you are dealing and can help guarantee a no-hassle pass to your next big break in net taxes.
You can’t just value the personal property. You have to value all of the entire property components, including the building structure, land improvements, and underlying land. You do this to find out the personal property’s relation to the whole. If you just appraise the personal property only, you get skewed results. For example, let’s say you had a purchase price of $10M and you value all of the components and got $20M. You appraise the personal property at $1M. If you use $1M as the 1245 property, you are overstating it. The ratio of the $1M PP value to the $20M total value, times the purchase price of $10M, should give you an allocated purchase price of the 1245 PP of $500,000.
The IRS *engineer-agent* who audits a cost seg that didn’t have a correct Purchase Price Allocation before doing the cost seg, would sure make his boss happy with the discovery of a $500,000 error.
You need an engineer or technical person to figure out the biggest bang for the cost segregation buck. The electrical wiring and the portion of the property’s electrical system that is dedicated to powering personal property is also 5-year property. Often, this amount is larger than the carpet, appliances, and other personal property put together! You need an engineer or other technical person, not just an accountant or tax planner, to figure this one out though.
Hi Benjamin,
You’re absolutly right about needing the land value and purchase prices to make a residential cost seg study valid. We don’t evaluate personal property apart from the purchase price and land value. We work with land values and purchase prices that are stated by the owner’s original appraisal which came with that property. Owner-estimates are not enough.
We always rely on this original documentation as the basis for the report. Our costing company (with over 70 years in the industry) absolutely rewuires this.
Also, their costing data does take into acount the special wiring for electrical components (I agree, a huge value as opposed to carpeting, etc), and as we understand it, accounts also for an assumed delivery and installation fee as well.
In essence, our costing partner is the outsourced engineer that does the valuation of such components. We don’t discount the importance of having aknowledgable partner, which is why we work with our particular costing company.