Which cost segregation study approach is required by the IRS?

[Julio Gonzalez]

In a previous post, I discussed the difference in each of the most common cost segregation study approaches. You can read about the differences here: Cost Segregation Study Approaches Explained

Let’s first start with what the approaches:

1. Detailed Engineering Approach from Actual Cost Records
2. Detailed Engineering Cost Estimate Approach
3. Survey or Letter Approach
4. Residual Estimation Approach
5. Sampling or Modeling Approach
6. "Rule of Thumb" Approach

So which of these approaches is required by the IRS?

First off, the approach that was utilized in the cost segregation study might not be explicitly mentioned within the cost segregation study report.

The IRS has not established specific standards or requirements for the preparation of the cost segregation study. They have addressed the issue of depreciation of components, but not the actual methodology of the study.

However, there are multiple documents that emphasize that all 1245 property determinations must be factual and supported by corroborating evidence. Additionally, the study must be completed by “qualified individuals” and “professional firms” that are competent in construction, design, auditing and estimation procedures for building construction.

So while a specific methodology isn’t required by the IRS, taxpayers must ensure that their depreciation deductions and classifications of property are substantiated with supporting evidence. Actual costs are obviously more accurate than estimates. However, there are times when actual costs are not available and a methodology must be selected in order to determine the estimate. Just ensure the cost data sources are very clearly documented. These estimated costs should then be reconciled back to actual costs or the purchase price.

Have you had a cost segregation study performed? Which approach was utilized?