Cost cutting options more often than not, sacrifice quality. Think of it this way, a Cadillac costs more, because of its superior quality. A Ford Pinto costs less, because of its lack of quality. You get what you pay for, right? And yes, I can make fun of the Pinto considering they are no longer in production. What I am trying to say here is that the importance of quality in cost segregation services and studies is crucial.This same concept goes for choosing the right cost segregation service. In addition to the financial burden you could acquire should your case be disallowed, think of the emotional burden that can ensue as well (loss of productivity and in-person interviews, just to name a few).
Where am I going with this? Keep reading to find out.
By simply doing a Google (or Bing) search, you’ll see a decent amount of cost segregation services claiming that their cost segregation services are fast, easy and cost-effective. Sounds great, right? From my research and experience, these services cut corners.
According to the IRS Cost Segregation Audit Techniques Guide (ATG), “substantiating the cost basis of each asset and reconciling total allocated costs to total actual costs,” is what makes a defensible (quality) cost segregation study. This method is the building block of what constitutes the engineering approach. To sum it up, utilizing the engineering approach will always be your best bet.
If you haven’t read our blog post Types of Cost Segregation Studies, be sure to do so as it will give you a greater insight on the various cost segregation approaches most commonly used in the industry and what the IRS considers defensible. On a side note, our cost segregation services only use approaches one and two (engineering approaches), as they are the most defensible when facing the IRS.
You may or may not know that there is no standard format for cost segregation studies. Cost segregation studies come in all shapes and sizes.
Chapter 4 of the ATG, Principal Elements of a Quality Cost Segregation Study and Report, does a great job at breaking down the top elements that encompass a “quality” study and report.
According chapter 4 of the ATG, “quality studies greatly expedite the Service’s review, thereby minimizing the audit burden on all parties.”
To put that into perspective, according to Chapter 4 of the ATG, regardless of what methodology you use, the below factors must be satisfied:
- Classify assets into property classes (e.g., land, land improvements, building, equipment, furniture and fixtures);
- Explain the rationale (including legal citations) for classifying assets as either § 1245 or § 1250 property; and,
- Substantiate the cost basis of each asset and reconcile total allocated costs to total actual costs.
Now that you have a better understanding of what constitutes a quality cost segregation study and report, how do you know if the cost segregation service you’ve chosen or considering is “defensible?”
Below is a high-level summary of some of the top principal elements that are commonly found in a “quality” cost segregation study and report. For a complete list and breakdown of the top principal elements, check out chapter 4 of the ATG.
- The study is prepared by person(s) with knowledge of construction and tax law
- While there are no strict guidelines on the qualifications of the preparer of a cost segregation study, a study itself does require the knowledge of construction and tax law. Additionally, having experience in cost estimating and allocation is highly desired. If a preparer has the knowledge and experience in all these aspects, then most likely the study and report will be considered “quality.”
- The methodology used is described, along with the steps taken to classify assets and determine costs
- A quality study will explain in detail the methodology used along with the steps taken to properly classify the assets and determine the costs.
- Proof of documents used to classify assets and determine costs
- This element is contingent upon whether the property is new or used. As a whole, existing documents are considered to be the most reliable. Examples of such documents includes, invoices, hard costs, drawings and blueprints. These documents more accessible the newer the property is.
- However, if the property was acquired (used) and the above mentioned documents are not available, the preparer should properly allocate the purchase price between the land, land improvements, building and other assets. Once these costs are allocated, a complete breakdown of costs for each of these components is necessary.
- For more info on how cost allocation works, check out our blog post Comparing Cost Segregation Software Options.
- Consistency across the board with data and costs
- A quality study ensures that assets are consistent with construction documents (ie. bid documents and invoices). One resource that is incredibly helpful and recommended by the IRS, is the Construction Specification Institute (CSI) MasterFormat. This strategy is used throughout the construction industry to establish consistency for organizing construction cost data.
- Extensive legal analysis to support property classifications
- A quality study ensures that each §1245 property classification is supported by relevant court cases. However, it is important to note that there are apparent inconsistencies between court cases. Instead, it is recommended that court cases are correlated with the specific facts and circumstances of the property.
- Reconciling total allocated costs to total actual costs for accuracy
- In a quality study, cost estimates are always reconciled to the purchase price of the property or a total project cost. A quality study will explain in detail the methodology used along with the steps taken to properly classify the assets and determine the costs.
- If you don’t allocate the costs of all the components of your property, you have failed to reconcile the total cost. For more information on the challenges of residual estimating, check out our blog post Comparing Cost Segregation Software Options.
As you can see, there are quite a few elements that are highly-recommended by the IRS to satisfy a “quality” cost segregation study and report. The biggest takeaway is that a quality cost segregation study always reconciles allocated costs to actual costs, and provides a defensible legal analysis of the items reclassified as personal property.
Unfortunately, there are cost segregation services out there that promise quick results and/or low cost options. However, in order to offer a “low cost” solution these providers have no choice but to cut corners on quality. Be sure to do your research!
Now that you understand the difference between cost and value, are you ready to begin your quality cost segregation journey? Titan Echo has several options that can handle your cost segregation needs (turnkey, do-it-yourself, or Echo Lite). For more information on these options, check out our pricing page.
Once you’re ready to get started, simply sign up for our Echo Learning Academy to begin the process. It’s only $25 per month. Alternatively, download the below eBook for a sneak peek of the Echo Learning Academy.