Does a cost segregation study increase audit risk?

The short answer

A well-documented engineering-based study does not, in our experience, invite examination. A study built on percentage rules of thumb without support gives an examiner something to pull on. The difference is method and documentation, not the strategy itself.

Why the IRS published a guide

After Hospital Corporation of America v. Commissioner in 1997 confirmed that property qualifying as tangible personal property under the old investment tax credit rules keeps that character for depreciation, the Service faced a choice: fight every study building by building, or publish a standard.

It published a standard. The Cost Segregation Audit Techniques Guide describes the thirteen principal elements of a quality study and the costing methodologies it considers reliable. It is public, and any owner can read the criteria their study will be measured against.

What examiners actually look for

Whether the preparer had construction or engineering expertise. Whether the costing method was appropriate and disclosed. Whether the total costed reconciles to the capitalised basis. Whether each classification has a stated legal basis. Whether a site inspection occurred and is documented. Whether indirect costs were allocated. Whether land was properly carved out.

Notice what is not on that list: the size of the reclassification percentage. A high percentage on a restaurant is unremarkable. The same percentage on a warehouse invites a question, and the answer needs to be in the report.

The practices that create problems

Percentage-only studies that assert a number without a takeoff. Residual estimating that backs into a figure. Classifying HVAC serving the building generally as personal property because it also happens to serve equipment. Treating general site grading as a land improvement. Failing to reduce basis for land. Ignoring the mid-quarter convention test.

What we do about it

Every report addresses all thirteen elements explicitly, cites authority for each classification, includes the photographic record, and reconciles to your basis. If a return containing our study is examined, we support the position at no additional charge — the report was written to be defended, and defending it is part of the job.