You probably know that preparing your clients’ cost segregation studies requires specialized knowledge of their industry. You might not realize, however, the importance of tax knowledge—especially when it comes to conforming the studies to new IRS Audit Technique Guides (ATGs).
Know the Rules Before Making Any Decisions
The Court of Appeals for the 11th Circuit has concluded that for depreciation purposes, a taxpayer couldn’t unilaterally change its original purchase price allocations in two asset purchase agreements entered into in connection with acquiring certain assets.
In Peco Foods, Inc. & Subsidiaries v. Comm., the taxpayer had attempted to make the modifications in order to secure quicker depreciation deductions following a cost segregation analysis. The 11th Circuit agreed with the Tax Court that the law had been applied correctly.
Case background showed that Peco Foods acquired one poultry plant from Green Acre Farm, Inc. in 1995 for $27,150,000 and, in 1998, one poultry plant from Marshall Dublin Food Corp. and Marshal Dublin Farms for $10,500,000. As part of the purchase agreements, both parties agreed to and included a purchase price allocation (PPA) in the purchase documentation.
At issue in the Tax Court case was the classification of a “Processing Plant Building” on one purchase and the “Real Property: Improvements” on the other purchase. Peco initially depreciated these assets as nonresidential real property (39-year) before performing a cost segregation study on each.
The Tax Court ruled the study invalid because of the PPA. The PPA went as far as delineating the costs for items such as specific process-related items, land improvements, buildings and goodwill. Further, the PPA was explicit about the definitions of real and personal property as they pertained to the specific transaction. In addition, the PPA contained specific language that the allocations were to be used for all purposes including financial accounting and tax purposes. The taxpayer also filed the detail listing with their tax return as part of the Form 8594 for their respective year of purchase.
The decision in Peco points out that one must pay attention and know the rules before making decisions on what you put into a purchase agreement, as this can determine your options including whether one can perform a cost segregation study.
The second case, AmeriSouth v. Commissioner, hinged on the allocation of rental real estate assets into appropriate classes for calculating depreciation expense and how a quality study pinpoints all shorter-life personal property, such as furniture, fixtures and equipment, and land improvements, from the longer life 27.5-year residential building life and non-depreciable land. Recently taxpayers have also qualified for 50% and 100% bonus depreciation on any newly placed-in-service personal property and land improvements.
In AmeriSouth, the judge decided that many of the assets of the petitioner’s 40-building, 366-unit apartment complex should be reclassified from personal property to building. AmeriSouth purchased a $10.25 million market-rate apartment complex in 2003 and spent $2 million in renovations. They hired consultants to perform a cost segregation study that resulted in increased depreciation deductions of approximately $1,412,000 from 2003-2005. The IRS commissioner subsequently denied deductions of more than $1 million. AmeriSouth then filed its petition to challenge.
One major point of this case: The court places the burden of proof on the taxpayer to provide support for why an asset should have a shorter depreciable life. AmeriSouth fell short in this area. If they had followed the ATG, the company wouldn’t have taken the position it did.
As we see in AmeriSouth, the taxpayer did not substantiate their position under IRS audit since they had sold the building before trial began. It is unknown how the case would have been decided if the taxpayer had been responsive in this case. AmeriSouth took many positions that most cost segregation providers do not take. An accurate analysis of the statutes and judicial precedent for the positions taken in AmeriSouth could have avoided a costly legal challenge in court.
A Quality Cost Segregation Services Provider Has Quality Tax Experience
Cost segregation services are not just a commodity where your client should pick the lowest bidder. Make sure your clients know that the best way to prepare a cost segregation study based on the latest ATGs is to choose a provider with thorough tax knowledge. If you partner with another firm for this service to clients, understand the credentials of your partner firm and their expertise in cost segregation. Contact us for help.