Tax preparers and their clients often cannot recognize quality differences among cost segregation service providers, leading to buying decisions based on who proposes the lowest fee or promises the highest tax benefit. However, the real test of quality is how the cost segregation results stand up in an IRS audit.
What are the consequences of an inferior cost segregation analysis?
In the recently released IRS Chief Counsel Advice #201805001, a cost segregation engineer prepared a report where the IRS found “the most egregious misrepresentations concerning the classification of property for tax purposes.” The opinion goes on to conclude the cost segregation engineer effectively “aided in the preparation or presentation of the returns of clients who understated tax liability through claiming excessive deductions for depreciation.”
As such, the consultant is liable (under Section 6701 of the tax code) for a $1,000 penalty per affected return or $10,000 per return if the taxpayer is a corporation. If multiple taxpayers are affected (for example, if Form K-1 is provided to multiple investors in a partnership), the penalty is multiplied by the number of affected returns. The penalty is further multiplied by the number of tax years in which an incorrect return has been filed.
Relying on a third party to perform a cost segregation study does not release taxpayers from potential negligence penalties associated with the underpayment of tax. In 2013, the IRS assessed negligence penalties on the taxpayer for relying on a bad cost segregation study (see Chief Counsel Memo #20125201F Taxpayer Negligence Penalty for Poor Cost Segregation Study). Considering the potential penalties at stake, taxpayers should be wary of cost segregation providers that are not certified.
Over the past 10 years, the guidance surrounding cost recovery and depreciation has changed substantially, making it very important to work with industry thought leaders who stay in front of the constantly changing rules. Consider for example the tangible property regulations or the many types and treatments of “qualified improvements” that have existed since 2001.
In 2006, the American Society of Cost Segregation Professionals was formed in response to the growing need for education, credentials, technical standards and a code of ethics within the cost segregation industry. The ASCSP published its own Minimum Quality Standards and Code of Ethics to which its members are expected to comply. Certified members of the ASCSP have a minimum of seven years direct experience performing cost segregation studies and have passed a certified exam. A consultant who has earned the title of Certified Cost Segregation Professional (CCSP) can help clients avoid the kind of problems addressed in the Chief Counsel Memorandum.