CPA & Business Advisory Blog

Limitations on the Use of Cost Segregation

Recently, it has become more common for business entities to have cost segregation studies performed on their real property in order to accelerate depreciation deductions for tax purposes.  The study is usually done by an engineer who breaks down the property from 39 year real property into 5, 7 or 15 year personal property.  This is considered a change in accounting method.

In a recent case (Peco Foods vs. Commissioner, TC Memo 2012-18) the IRS and tax court disallowed the application for the change in accounting method requested due to a cost segregation study.

The case involved the acquisition of two poultry processing plants.  Both acquisitions were considered a transfer of assets that constituted a trade or business.  The first allocated the purchase price to 26 assets, one of which was a “processing plant building” and the rest was personal property under Section 1245.  The second allocated the purchase price to three assets (land, improvements, machinery/equipment furniture/fixtures).  On the tax return of the year related to the second acquisition, the taxpayer requested a change in accounting method pursuant to the cost segregation study that was done on the building from acquisition #1 and on the improvements from acquisition #2.

This was denied since both transactions were asset acquisitions where two parties agreed on the allocation of consideration.  Each of the agreements was unambiguous and enforceable.  The fact that the taxpayer used the word “building” indicated there was no intention to allocate purchase price to assets contained in the building.  In addition for the second acquisition, since the taxpayer listed subcomponents, they were aware that there was equipment and furniture so if they intended to allocate additional amounts to those items, it should have been done at the time of the agreement.

If a cost segregation is important to the purchaser in an asset deal, a rough study should be obtained before the purchase agreement is finalized or make sure that the acquisition contract specifies that what is being acquired is the building and its cost-segregatable components.  In other words, do not have specific allocations.

Have questions about cost segregation studies? Post a comment below or contact our Tax Planning & Preparation Group at 440-449-6800.

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