The popularity of cost segregation for real estate has been rapidly increasing over recent years. Many accounting firms now have whole divisions devoted to performing cost segregation studies and are enthusiastically marketing these services. The potential tax benefits of cost segregation are cleartangible personal property and land improvements can be depreciated significantly faster than the rate at which a building can be depreciated. Therefore, since cost segregation allocates to tangible personal property and land improvements whatever portion of the cost is allocable to them, the process enables a taxpayer to increase the rate at which it depreciates the cost of real estate.
However, the IRS seems to increasingly be giving cost segregation a close look on audit, and we may be seeing the beginnings of increased litigation in situations where the IRS considers cost segregation to be abused. In a recent case involving cost segregation, the Tax Court began by noting the tax benefits of accelerated depreciation through cost segregation and asserted that it was “tempted to say this is why [the taxpayer] throws in everything but the kitchen sink to support its argumentexcept it actually throws in a few hundred kitchen sinks, urging us to classify them as ‘special plumbing.’” Unfortunately, notwithstanding the Tax Court’s wit, real estate owners may not find this case humorous.
