6B — January 27 - February 9, 2012 — Shopping Centers — Mid Atlantic Real Estate Journal
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on Smith owns multiple commercial buildings. All have been either pur- By: Eli Loebenberg and Moshe Hildeshaim, Madison SPECS Tax court ruling recommends cost segregation studies done by professionals J
he hire a cost segregation ex- pert? Can his accountant seg- regate the costs for him? Or perhaps Mr. Smith can do it himself. He knows all the costs associated with the buildings. Can he just use the “rule of thumb” approach and segregate the costs himself? My advice to Mr. Smith is to save himself a headache (and possible prob- lems with the Department of Revenue) and hire an expert. He is better served hiring a qualified cost segregation firm to prepare the studies. It appears even the Depart- ment of Revenue agrees with this advice. It reached the same conclusion in the case
of Ronald Pearce and Daryl Pearce, Plaintiffs, v. Depart- ment of Revenue, State of Or- egon, Defendant (Oregon State Tax Reporter). In Pearce vs. the Dept. of Revenue, the Plaintiffs owned properties that qualified for depreciation deductions under Federal and Oregon law. These properties are ordinar- ily depreciable on the 39-year schedule applicable to build- ings. In order to distinguish the buildings from their related “tangible personal property,” such as equipment, furniture, and fixtures, which qualify for depreciation deductions on an accelerated schedule of between five to seven years, the Plain-
tiffs prepared their own cost- segregation analysis of their properties. Although Plaintiffs had no special experience in applying the cost-segregation methodology, they believed that their analysis was proper because it followed the “‘rule of thumb’ approach,” which is based upon “a preparer’s ‘expe- rience’ in a particular industry.” Plaintiffs used the results of their cost-segregation analysis including accelerated deprecia- tion deductions, in their 2004 return. On August 4, 2009, and Au- gust 6, 2009, Defendant sent Plaintiffs Notices of Tax De- ficiency. The tax deficiencies
arose fromDefendant’s denial of Plaintiffs 2004 cost-segregation analysis and Defendant’s conse- quent disallowance of Plaintiffs’ accelerated depreciation deduc- tions. In a letter dated March 2, 2010 the Defendant upheld its denial of Plaintiffs cost-segre- gation analysis explaining that the “rule of thumb” approach that Plaintiffs used “should [be] viewed by the Department of Revenue with caution, since it lacks sufficient documenta- tion to support its allocation of costs” and that Plaintiffs failed to substantiate their costs or prepare a timely analysis. Plaintiffs failed to satisfy their burden of proof in regards to accelerated depreciation through cost segregation. The IRS issued an Audit Technique Guide (ATG) to help guide their examiners when they encounter a return that uses cost segre- gated items for depreciation. The ATG instructs examiners to view the “rule of thumb” ap- proach used by Plaintiffs with caution because the results are “based on a preparer’s ‘experi- ence’ in a particular industry” and “[lack] of sufficient docu- mentation to support its alloca- tion of project costs.” Chapter three of the ATG states in part: “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 esti- mates. However, in situations where estimation is the only option, the methodology and the source of any cost data should be clearly documented. In addi- tion, estimated costs should be reconciled back to actual costs or purchase price.” A “quality” cost segregation study is “both accurate and well documented.” Ataxpayer’s estimated assumptions, based on guesses without support- ing records, could not form the basis for acknowledgement of a plaintiff ’s claim. In the Pearce case, Plaintiffs used a “written inventory” to allocate values to fixtures and cabinets. Plaintiffs did not sub- stantiate their cost allocation using actual costs. Instead, they merely used their own estima- tions or assumptions with no supporting records. In doing so, the Ronald and Daryl Pearce failed to clearly document the
chasedor con- structed over the last two years. Jon’s accountants recommend a cost segrega- tion study on these build- ings as this
Eli Loebenberg
will create additional cash flow and reduce his overall tax li- ability – allowing for what Jon does best – the purchasing of additional properties. Who should prepare these studies for Mr. Smith? Should
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