Great CPAs are quarterbacks for all financial matters affecting a company’s health. As a tax strategy, cost segregation is not performed by general business CPAs, though we do partner with and augment their tax mitigation work for their clients. Cost segregation requires both in-depth engineering and niche tax knowledge – not something most CPAs possess.
Cost segregation provides cash flow and income tax savings to owners of all types of commercial real estate and build-outs, by accelerating depreciation, decreasing taxable income. If you own commercial real estate – whether multi-family property, leasehold improvements, office renovation, distribution center, medical offices or facilities, or even ski resorts and golf courses – you should be using cost seg.
Determining the quality of the cost segregation provider
Because cost seg is a growing field with a lot of new adopters, including many CPAs, the ability to determine the quality of a provider has become more important than ever before. Like any growing field, late adopters scramble to cash in on this growth strategy by offering low-cost, low-effort studies that put uneducated buyers at risk. Regional-sized firms are at the greatest risk of providing low-quality studies because their network affiliates are not chosen for their effectiveness and quality. They are chosen for their ability to provide low-cost and high profitability to the network CPAs. Of course, there are always exceptions.
By asking the four questions below, CPAs and their clients will determine whether a cost segregation provider has the knowledge, expertise, and methodology to provide quality work. Or if their studies should be avoided entirely.
1. What approach do you use for cost segregation studies?
You only want to work with a provider using the Detailed Engineering Approach. These studies go through every inch of electrical conduit, every foot of stormwater management pipe, each bolted down bollard to provide the maximum accelerated depreciation. Providers who do not spend the time to examine your property with this detail miss significant value, and create audit hazards for you.
Though there is no such thing as being IRS audit ‘bullet proof’, by using the highest standards set forth by the IRS in its Audit Technique Guide (ATG), you can ensure that the methodology used is favored by the IRS and that all items are allowed by tax court precedent. Though the IRS Audit Technique Guide does not require any specific methodology when it states concerns about the validity and accuracy of other methodologies, commercial real estate owners should avoid them.
2. Describe a typical property tour
Quality studies require an average of 3-4 hours on-site, by both an engineering and accounting professional. Some properties require as much as several days on-site, such as a large building with great complexity, like a hospital.
A quality study should photographically document all visible segregated items. ‘Drive by’ studies where a tour lasts for only a few minutes and provides limited documentation do not meet this highest standard.
If a provider is simply breaking down a building into percentage categories, for example, 30% electrical, this is a clear indication you have received a Rule of Thumb study. ATG states “An examiner should view this approach with caution since it lacks sufficient documentation.” Do you want to hire a firm using a methodology that the IRS views with caution?
3. Will the reports provide itemized breakouts of all segregated items, and how small are the items they examine?
You want to receive a cost detail of the project where each segregated item is broken out as a separate line item, with indicated value, short life, and the source of that value, be it a receipt, or an approved engineering estimating source. You also want to receive a study with items as small as the electrical outlets indicated. When you are looking for study value, it is always the little items that are overlooked. When added together over the course of a building, these small items provide significant value to the owner. Their presence in an itemized cost detail shows the provider’s dedication to detail, and to providing you the best available value for your study.
4. Is your referred firm a part of a CPA’s required referral network, or are they referred specifically due to their expertise?
This is an important question for CPAs to ask when they are a part of a medium-sized regional firm that participates in an affiliate network. It is also important for clients to ask their CPAs. The mergers of large CPA firms continue. In order to compete, regional firms are joining together to compete against these industry whales. Sometimes the service offerings increase can benefit clients. However, with specialty services like cost segregation, CPAs and their clients are at risk of receiving poor studies from unqualified providers. In the past year alone, we have worked with two large regional firms in upstate New York, who discovered that their cost segregation affiliate firm providers were using the highly suspect Rule of Thumb methodology. A methodology which the IRS specifically views with caution.
By asking these questions of your intended cost segregation provider you can begin to understand the quality of their studies and ensure that the work you receive will maximize your study value, and comply with IRS best practices.