Make Sure your Accountant Reviews Cost Segregation Studies by Angie Adames, CPA

Posted on April 12, 2018 by Angie Adames

Cost segregation studies have proven to be valuable tools for helping taxpayers who have constructed, purchased, expanded or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes. However, a recent Memorandum issued by the IRS highlights the fact that relying on a third party to perform a cost segregation study does not release taxpayers from potential negligence penalties associated with the underpayment of tax.

In the matter before the IRS Chief Counsel, a small business hired an engineer to conduct a cost segregation study, which the business ultimately used to accelerate depreciation deductions over five years, rather than 39, and create a significant tax loss for the years at issue. Nonetheless, the IRS determined that the business understated its tax liabilities by claiming excessive deductions based upon the engineer’s report, which the IRS characterized as “the most egregious misrepresentation” of the useful life of a building’s components. Ultimately, the IRS found the taxpayer to be negligent in meeting its tax burden while imposing penalties on the engineer for “aiding and abetting” the tax underpayment.

While it is true that the engineer will pay for his aggressive cost segregation study, it is important for real estate professionals to remember that just because they paid a licensed engineer to develop a report, does not mean that the report is accurate. Nor does it alleviate taxpayers of their responsibilities to substantiate all claims of income and deductions. This is especially true when considering the nuances in the tax laws relating to bonus depreciation, including appropriate allocations made between land and buildings, the definition of units of property (UoP) and the decision to capitalize or expense repairs and improvements.

With this in mind, it is critical that real estate professionals engage tax advisors and accountants to review cost segregation studies in order to identify potential inaccuracies and ensure that depreciation deductions and reclassifications of building components make sense. Having another professional agree that a cost segregation study is valid will help to reassure taxpayers that their claims have a better chance against a potential IRS audit.

About the Author: Angie Adames, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where she provides tax and consulting services to real estate companies, manufacturers and closely held business. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at