This blog discusses an article in the AICPA’s Tax Adviser entitled, “Is the Value of Cost Segregation Depreciating?” The title of the article is very misleading, because if you read the article through to the conclusion, it clearly states that there’s still incredible value in cost segregation studies than there were before these cases were decided, not less value. The title really gives the wrong impression.
Two cases are addressed in the article, the first of which is AmeriSouth. That was a situation where the IRS attacked a cost segregation study that was done on several residential apartment units AmeriSouth was trying to reclassify as shorter-life assets that the cost segregation study had identified. The IRS wanted to reclassify them as 27.5-year structural components instead.
Before the case went to trial in tax court, the original owners who were being audited (and who had the cost segregation study done) sold the property. After that, they did not communicate at all with the tax court, through their attorneys or by themselves, and the case went to trial. So, the only thing that the tax court judge had to rule on were the arguments presented by the IRS. That’s very significant, because, looking at the details of this case, I firmly believe that, had the defendant cited the five criteria in the Whiteco Factors, many of these asset re-classifications would have been upheld. A large body of precedential cases support much of what the cost segregation study accomplished.
It does appear that the cost segregation study done in AmeriSouth was more aggressive than what Concord Group does, and frankly, we disagreed with some of the classifications. You’ve got to have a firm that understands what can or cannot be reclassified as shorter-life assets within an appropriate cost segregation study.
The open-ended question at the end of the AmeriSouth case was, “Can the IRS use this case in the future as a precedent to support their position that some of these assets cannot be reclassified?” It’s our firm belief that there are plenty of other precedent-setting cases prior to AmeriSouth that would be easily defensible. AmeriSouth is a non-issue; it does not affect the effectiveness of cost segregation studies. In a situation where a case is, in essence, not defended, it will not hold as much merit as a case that was fully defended and pursued.
The second case that was cited in the article is Peco Foods. A buyer purchased an entire business: the building plan, the equipment and everything involved with the business. That’s a critical point – it was a business purchase rather than a single-asset purchase. Because it was a business purchase, the buyer had a cost segregation study performed so as to split up shorter-life assets. The issue was that in the purchase contract for the business and the assets, the purchase price was already allocated amongst the various classes of assets. It’s a long-term, often upheld understanding that, when the allocation of these asset classes is spelled out in a contractual agreement, that agreement is binding according to U.S. Code Section 1060. Code Section 1060 has been around for a long time.
Nothing about this case surprised me at all. And frankly, I am surprised that it even made news anywhere, because it simply reaffirmed to all of us who understand what cost segregation studies can do that we have to adhere to the contractual arrangement. Even if the allocation makes no sense at all, even if it appears to be inaccurate and not well thought out. We’re bound by that. We have no latitude. In Peco, when they purchased the business, it was a chicken-producing entity, so there were structures, chickens, processing plants and processing equipment. There was an attempt to reclassify some of those assets and shorter-life assets. But they couldn’t do that, because unfortunately, they were bound by what the contract spelled out.
You’ve got to work with a cost segregation study specialist who understands the underlying taxation principles behind some of these things before even setting out to do the study. At Concord Group, one of the first things we ask in an initial inquiry of a potential client is, “Do you have a contract for the purchase of the business that is covered by these assets?” It’s one of the preliminary questions that must be asked, along with a series of other questions. And if you don’t ask these questions, you’re going to be led down the wrong path.
One other thing to note with the Peco case is that the whole lawsuit could have been averted with very simple language that would have allowed them to do a cost segregation study and obtain the tax advantages that occurred during the transaction. In essence, had they not called the building’s “buildings” but “facilities,” that would have allowed for a cost segregation study at a later time. So it’s not only the knowledge of how to do this but it’s the knowledge of what to do during the process that is also important. In the sale contract for the business, they specifically noted that they were buying “buildings.” Simply using a more generic term would have allowed them to do a cost segregation study.
The light this case could shine on the issue is that cost segregation studies, while important even after you purchase a building, are equally as important while you’re negotiating the purchase of a business. Because if you’re aware of these techniques as you’re purchasing it, you can change or manipulate the wording in the contracts so that the result will be the same, but perhaps you can make the allocation “contingent on the final results of a cost segregation study.” This simple change of nomenclature can have a big effect on the tax consequences of the contract.
A lot of information was written about this case as it relates to cost segregation; during the purchase of a business that includes real estate, it is advantageous to the buyer to have a cost segregation study done before the buy-sell agreement is complete, so that they have full knowledge of what assets are classified as personal property or real property. If it did nothing else, this case opened the eyes of both the accountants and the lawyers involved with the transactions to the fact that a cost segregation study should be looked at pre-sale versus post-sale.
In conclusion, the last statement in the article really sums it all up. It says, “It is fitting that analyzing beneath the surface of the recent holdings of AmeriSouth and Peco suggests that the usefulness and value of properly performed cost segregation studies is enhanced rather than diminished.” They were obviously trying for flair and not content with this article, because the headline should have been similar to the conclusion. Instead, they made it sound like the exact opposite was true.