In-House Cost Segregation Studies

A Cost Segregation Study performed In-House, by employees of the company, is often times reviewed with more scrutiny by the IRS.  Here is the summary of the Boddie-Noell Enterprises court case:

• The Company owned and operated approximately 240 Hardees restaurants.
• The two employees who conducted the original cost segregation study used an estimate of a existing study conducted by Hardee’s Food Systems which indicated 24% of the assets qualified for ITC.  They sent questionnaires regarding costs to contractors but didn’t keep those records.
• The IRS examined the methodology and threw out the results of the study.
• The company took it to court and hired an individual cost segregation practitioner to conduct studies on 7 properties prior to trial.
• The practitioner did not visit any of the sites.
• Indirect costs were improperly allocated to the estimated take offs (i.e. the allocation of excavation and other site work to electrical, HVAC, etc.)
• Some costs were taken from estimating books others were randomly assigned or adjusted from the estimating books.
• After examining the methodology the court stated, “The methodology employed by plaintiff…. was at best, unusual.” They also stated that the results of the 7 studies performed by the individual cost segregation practitioner appeared to be “based on after-the-fact speculations”.  The court also found a lack of contemporaneous evidence supporting the corporations’ claims.

A couple of other important points from this case:

• The court found that the suspended ceilings did not qualify as a short life component.
• The external orange roof panels specific to Hardees design did not qualify as a short life component.
• HVAC did not qualify as a short life component.
• Drive up window units did not qualify a short life component.

Cost Segregation studies should not be taken lightly.  With the issuance of the IRS Cost Segregation Audit Techniques Guide in 2004, it shows that the IRS knows what separates a good study from poor one.  A study conducted by an independent firm is looked at more favorably than one conducted “in-house”.  However, it is not safe to assume that any independent cost segregation provider will do.  

Before deciding on a provider, we recommend that you ask to see a sample of their study so you can compare the methodology used and the level of detail provided.