While the title of this article probably invokes a response from the reader such as “well – that’s a no-brainer”, that is exactly what happened in the case of AmeriSouth XXXII, Ltd v. Commissioner of Internal Revenue. The recently released T.C. Memo 2012-67 has caused quite a stir within the accounting and cost segregation community.
AmeriSouth acquired an apartment complex in 2003 for $10.25 million. Immediately following acquisition, AmeriSouth proceeded to renovate the property, incurring costs in the area of $2.0 million. AmeriSouth engaged the services of a cost segregation firm that took the position that $3.4 million could be classified in 5 and 15-year lives for depreciation purposes. The IRS disagreed with the taxpayer’s position and the taxpayer filed a petition to challenge the Commissioner’s adjustments.
Shortly thereafter, AmeriSouth sold the property and stopped communicating with the court as well as its own attorneys. The situation became so bad that the court permitted the AmeriSouth attorneys to withdraw from the case. When asked to file a post trial brief, AmeriSouth ignored the request. Perhaps they assumed that everything would just “go away”. Unfortunately for AmeriSouth, that would not be the case and the process went on without them.
On the surface, it would appear as if the cost segregation consultant made some serious errors and was overly aggressive with some of their interpretations in conducting the cost segregation study. Further, according to the Court, the consultant did not demonstrate sufficient evaluation, validation or substantiation of many assets they called “special use”. The Court also considered the IRS expert witness as being more reliable than the taxpayer’s consultant in recreating costs using the consultant’s own work papers (which strangely were not entered into evidence) citing that it was an attempt to undermine the Commissioner’s characterization of what they held.
The consultant missed the mark on many assets and did not provide the appropriate level of detail upon which to provide a convincing argument to the Tax Court. Some items include the following:
- Water Distribution Systems
- Sanitary Sewers
- Site Electric
- “Special HVAC and Plumbing”
- Interior Millwork
- “Special Painting”
Bedford’s Observation and Commentary
In several instances, the cost segregation consultant made some serious errors with their interpretation of relevant tax law, court cases and Revenue Procedures in preparing their study and assigned incorrect recovery periods to certain assets. Other than these errors, this case underscores the importance of engineering-based studies conducted and written by the same qualified individual. Cost segregation scope and methodology is critical – especially on acquired properties, as was the case in AmeriSouth.
Additional documentation supporting the consultant’s position regarding “special electrical” might have included actual photographs of electrical panels, and devices with actual load-based electrical calculations might have provided a more defensible position. Similarly, photographic documentation and specific delineation of appliance connections could have supported those assets having 5-year lives. Concise and accurate descriptions of these assets are always beneficial. Simply labeling something as being “special” has no relevance whatsoever.
While it is difficult to determine the credentials of the person who conducted the on-site evaluation and ensuing engineering analyses (if any), it is safe to assume that the report did not stand up to IRS scrutiny as written. Given the taxpayer’s unwillingness to follow procedures, coupled with a series of events that lead up to this decision, it is no wonder that the IRS got exactly what they wanted. The good news is that a comprehensive cost segregation study conducted by a qualified individual will be able to withstand any scrutiny by the IRS. Of course, when challenged by the IRS, the taxpayer and their consultant should actually have an opportunity for their day in court. The results could have been different on a number of items had AmeriSouth actually shown up.