The IRS published an updated version of the Cost Segregation Audit Technique Guide (ATG) on June 1, 2022. The ATG was updated to reflect changes in the tax law from the Protecting Americans from Tax Hikes (PATH) Act, the Tax Cuts and Jobs Act (TCJA), the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and the Taxpayer Certainty and Disaster Tax Relief Act of 2020. The updated version of the ATG represents the first changes since 2017.
What is the Cost Segregation ATG?
The Cost Segregation Audit Technique Guide was developed to assist IRS examiners in the review and examination of cost segregation studies. The primary goals are to provide examiners with an understanding of how and why cost segregation studies are preformed, what to look for when reviewing cost segregation studies, and when certain issues identified need further examination.
The legislative and judicial history of asset classification and depreciation is long and complex. The calculation of depreciation deductions dates back at least as far as 1913 and has been the source of much controversy between the IRS and taxpayers. The ATG attempts to provide a broad overview of this history and to document the legal framework within which cost segregation studies are performed. This includes a discussion of the legislative history and certain important tax court cases that address the relevant issues.
There are several common approaches to completing cost segregation studies, but at this time neither the IRS nor any group or association of practitioners has established any requirements or standards for the preparation of cost segregation studies*. For this reason, the ATG also summarizes the various approaches to cost segregation and provides what the IRS considers to be the “Principal Element of a Quality Cost Segregation Study and Report”.
Generally speaking, the IRS considers a “quality” cost segregation study to be any study that is “both accurate and well-documented” with regards to the following three components:
- Classification of assets into property classes
- Explanation of the rationale for classifying assets as either Section 1245 or Section 1250 property
- Substantiation of the cost basis of each asset, including a reconciliation to the total actual costs
The ATG then expands on this definition by providing 13 principal elements of a “quality” cost segregation study and 9 principal elements of a “quality” cost segregation report. The principal elements of a “quality” cost segregation study are as follows:
- Preparation by An Individual with Expertise and Experience
- Detailed Description of The Methodology
- Use of Appropriate Documentation
- Interviews Conducted with Appropriate Parties
- Use of A Common Nomenclature
- Use of A Standard Numbering System
- Explanation of The Legal Analysis
- Determination of Unit Costs and Engineering “Take-Offs”
- Organization of Assets into Lists or Groups
- Reconciliation of Total Allocated Costs to Total Actual Costs
- Explanation of The Treatment of Indirect Costs
- Identification and Listing of § 1245 Property
- Consideration of Related Aspects
The IRS expects that the degree to which a cost segregation study and accompanying report conforms to the principal elements described in the ATG, will dictate the scope and depth of an examination. With higher “quality” studies and reports expediting the exam process and minimizing the burden on the taxpayer. To that end, the ATG provides examiners with recommended steps for evaluating the adequacy and accuracy of a cost segregation study.
Finally, the ATG provides discussions of certain related aspects (e.g., I.R.C. § 263A, Change in Accounting Method, etc.) and industry specific guidance for casinos, restaurants, retail, pharmaceutical/biotechnology, auto dealerships, and auto manufacturing.
What’s New in the Cost Segregation ATG?
The majority of the 2022 updates to the Cost Segregation ATG were necessitated due to changes in tax law that have occurred since the prior version was issued. These changes relate to I.R.C. § 263A, Change in Accounting Method, Depreciation, Bonus Depreciation, Section 179 deductions, Section 179D deductions, and Qualified Improvement Property. Generally, these changes to not impact the methodologies or procedures employed to complete a cost segregation study.
Another change to the ATG is the addition of “issue specific guidance” related to the treatment of the electrical distribution system (New Chapter 8). This new chapter provides procedures for the proper allocation of a building’s electrical distribution system using the “functional allocation approach”. This approach was first utilized in the case Scott Paper v. Commissioner (1980) and involves allocating the costs of the electrical distribution system proportionally by electrical demand load to the various items served by the system. In the context of cost segregation, the approach involves calculating the demand load associated with items of Section 1245 property as a percentage of the total demand load of the system and then applying that percentage to the total cost of the electrical distribution system to calculate the cost of the system that is associated with Section 1245 property. The ATG provides that if the taxpayer uses a correct functional allocation approach, as defined in the ATG, the examiner should not challenge the use of the approach.
The functional allocation and similar approaches have been commonly used by cost segregation professionals for many years, so this new chapter in the ATG is certainly nothing new to the industry. But it does provide a useful summary and description of the method that can serve as a guide to both examiners and practitioners and which will hopefully reduce dispute during future examinations of cost segregation studies.
Summary
The practice of cost segregation has a long and established history, but it has also been the source of frequent disagreement between taxpayers and the IRS. The identification and classification of assets for depreciation purposes continues to be largely dependent on facts and circumstances, which inhibits the development of bright-line tests for making such determinations. This dependence on facts and circumstances will continue to contribute to disputes between taxpayers and the IRS. However, the Cost Segregation ATG is a critical resource that will help to minimize these disputes and create better alignment between the taxpayers and practitioners that perform cost segregation studies and the IRS examiners that review them.
*The American Society of Cost Segregation Professionals (ASCSP) provides technical standards and a Code of Ethics within the cost segregation industry and is a valuable resource for cost segregation professionals. However, there is no legal or regulatory requirement for cost segregation studies to be performed by members of the ASCSP or in accordance with the standards it has developed.
