Cost segregation is a powerful tax strategy that allows commercial property owners to accelerate depreciation and unlock significant cash flow. However, when done incorrectly, or by the wrong provider, it can raise red flags with the IRS. That’s why understanding the IRS cost segregation guidelines and audit procedures is essential to staying compliant and avoiding unnecessary scrutiny.
In this blog, we’ll walk you through how to conduct a cost segregation study the right way, in alignment with the IRS Cost Segregation Audit Techniques Guide, and how to prepare in case of a review.
What is a Cost Segregation Study and Why is it Important?
A cost segregation study is an engineering-based analysis that breaks down the costs of a commercial property into individual components. Instead of depreciating the entire building over 27.5 or 39-years, a cost segregation study identifies assets that qualify for accelerated depreciation over 5, 7, or 15 years.
The benefit? Increased near-term cash flow and a lower taxable income, especially in the early years of ownership or after improvements.
Whether you’re constructing, purchasing, or renovating a property, a proper study can save you hundreds of thousands in taxes—but only if done right and in accordance with cost segregation guidelines.
IRS Cost Segregation Guide: Key Considerations
The IRS Cost Segregation Audit Techniques Guide (ATG) is the IRS’s primary reference document used to assess the validity and accuracy of cost segregation studies. This guide outlines:
- Acceptable methodologies for classifying building components
- Required documentation and substantiation
- Qualifications and expectations for study preparers
- Red flags that may trigger an audit
The audit technique guide for cost segregation also makes it clear that not all studies are created equal. Engineering-based reports prepared by qualified professionals are favored, while studies that rely solely on rule-of-thumb estimates or shortcuts can attract unwanted attention.
How to Stay Compliant With IRS Cost Segregation Guidelines
Staying compliant with IRS cost segregation guidelines starts with the right approach. Here’s how to ensure your study meets the IRS’s standards:
- Use Engineering-Based Methods: These provide the most accurate breakdown of property components and are explicitly supported in the IRS ATG.
- Provide Detailed Documentation: A quality study will include photos, cost basis allocations, and clear explanations of methodology.
- Engage Qualified Professionals: The IRS expects preparers to have construction, engineering, or valuation experience.
- Avoid Over-Aggressive Allocations: Don’t attempt to accelerate assets that don’t clearly qualify under IRS rules.
Following the cost segregation study IRS standards helps reduce risk and provides a solid defense if your return is ever examined.
IRS Cost Segregation Audit Techniques: What You Need to Know
Understanding how the IRS approaches audits can help you avoid them altogether. The IRS cost segregation audit techniques guide outlines what agents look for, including:
- Studies not tied to actual construction costs
- Use of overly aggressive asset classification
- Lack of substantiation or source documentation
- Preparers lacking credentials or construction/engineering knowledge
The audit technique guide cost segregation also emphasizes the need for consistency between your tax return and the cost segregation report. If discrepancies are found, it can open the door to a deeper audit.
Best Practices to Avoid an Audit When Conducting a Cost Segregation Study
Avoiding an audit starts with best practices grounded in transparency and precision. Here’s what you can do:
- Choose a Trusted Provider: Work with a firm that specializes in engineering-based cost segregation studies and has a strong track record—like CSSI, which has completed over 55,000 studies with no disallowed reports or audits.
- Ensure Full Compliance: Verify that your provider follows the IRS cost segregation audit techniques guide and uses accepted methodologies.
- Keep Thorough Records: Maintain detailed documentation and reports in case of IRS inquiries.
- Avoid DIY Approaches or Low-Cost Providers: These often lack the rigor and expertise necessary to meet IRS standards.
How to Prepare for a Cost Segregation Audit
While a well-executed study should reduce audit risk, it’s smart to prepare. Here’s how:
- Have the Study Readily Available: Include your cost segregation report with your tax documentation.
- Align Return Entries with the Study: Ensure your depreciation schedules match your study findings.
- Be Ready to Explain Classifications: Understand why certain assets were classified for shorter lives.
- Lean on Your Provider: Work with a firm like CSSI that offers full audit support at no extra charge.
Preparation isn’t just about defense—it’s about confidence in the accuracy of your study.
Conclusion
A cost segregation study can unlock tremendous tax benefits for property owners—but only when it’s done right. The IRS has laid out clear expectations in the cost segregation audit techniques guide, and following those guidelines is critical to avoiding scrutiny.
At CSSI, we’ve helped thousands of investors and commercial property owners accelerate depreciation safely and effectively. With over 55,000 engineering-based studies completed, and zero IRS challenges, we know how to keep you compliant and maximize your tax savings.
Let us help you lower your tax liability and protect your investment. Reach out to CSSI today to get started with a compliant, audit-ready cost segregation study.
