Is the value of cost segregation depreciating?

• Author: Blazek, Mark W.

Recent decisions in the cases AmeriSouth XXXII, Ltd., T.C. Memo. 2012-67, and Peco Foods, Inc., T.C. Memo. 2012-18, have been announced as IRS victories that call into question the validity of cost-segregation studies and their value to taxpayers. But a closer analysis of each ruling suggests that any purported demise of cost-segregation studies may be premature.

In AmeriSouth, the IRS challenged the classification of component costs of AmeriSouth's large apartment complex properties. AmeriSouth had used the services of a company purportedly specializing in asset classification and cost-segregation analysis for federal income tax purposes. Despite the cost-segregation study, the IRS argued that many of the types of component costs of the properties that the taxpayer treated as personal property or land improvements, in accordance with the conclusions of the cost-segregation study, should properly be classified as costs of structural components of the buildings to which they pertained.

The court generally held in favor of the IRS, finding that a significant portion of the component costs that were classified as personal property or land improvements in the cost-segregation study should be properly classified as residential rental real property. For "tax headline" purposes the ruling could be summed up as, "Cost-Segregation Study Does Not Withstand IRS Challenge."

In Peco, the IRS challenged the taxpayer's ability to classify assets for federal income tax purposes in accordance with the results of a cost-segregation study. The subject property was acquired by the taxpayer in two separate asset purchases, each constituting the purchase of a trade or business for federal income tax purposes. As such, the transactions were subject to Sec. 1060. In connection with the transactions, the parties to each transaction constructed and agreed to an allocation of the respective purchase prices among a list of identified assets.

Among the assets to which allocations of the respective purchase prices were made were the following building property assets: processing plant building, two holding sheds, and hatchery real property. Subsequently, the taxpayer obtained a cost-segregation analysis of the building property assets. The taxpayer used the asset classifications determined in the cost-segregation study for purposes of depreciating the component costs of the building property assets.

The IRS argued that the taxpayer had to classify the entire cost of the building property assets as a building, since the taxpayer had agreed to the specific allocation of a portion of the respective purchase prices to building property assets. The court held in favor of the IRS, finding that the specific allocation of purchase price to building...