In a lengthy decision (Amerisouth XXXII, Ltd., et al. v. Commissioner, Tax Court Memo 2012- 67), the United States Tax Court decided yesterday that a taxpayer’s cost segregation analysis was, for the most part, ineffective to establish differing components for depreciation purposes. The taxpayer purchased a large apartment complex in 2003. Soon thereafter, the taxpayer engaged an independent firm to prepare a cost segregation analysis of the complex. As a result the taxpayer allocated its total cost of the complex to a number of differing components with different depreciable lives ranging from 5 years to 27.5 years. On examination, the IRS asserted that the complex qualified only for 27.5 year depreciation. The court describes the matter this way:
The Commissioner argues that with minor exceptions the apartment complex is one asset that AmeriSouth must depreciate over 27.5 years. AmeriSouth argues that, whatever the apartment complex may look like to an untrained observer, to a tax adept it is not a single asset but a collection of more than 1,000 components depreciable over much shorter periods.
The court then carefully analyzes the cost segregation report along with the applicable tax laws. In sum, the court held that the taxpayer’s allocation of costs for the part was ineffective. In particular, the court determined that the starting point is not a barebones building structure with additional separate components. Rather, the determination focuses on whether the items are structural components of the building. With that, the court held that the water-distribution system, sanitary sewer system, gas lines, most electrical systems and equipment, HVAC and plumbing (including the kitchen sinks) are structural components subject to 27.5 year depreciation.
While the taxpayer for some unknown reason chose not to press its case through counsel or post-trial briefs, the court nonetheless reached a decision rather than simply dismissing the case. With this win, it seems likely that cost segregation (like its predecessor component depreciation) will become a focus for IRS auditors examining real property owners.
The case may be found here.