In the recently released Chief Counsel Memo #20125201F, the IRS makes it clear that even if you engage a third party to perform a cost segregation analysis, taxpayers cannot avoid penalties for aggressive positions taken in the cost segregation report.
The taxpayer attended a presentation that addressed open-air parking structures in which the presentation slides indicated certain regulations support the argument that parking structures belong in the land improvement category. The taxpayer hired the firm to conduct a cost segregation study that took this position. Under audit, the taxpayer argued that it had reasonable cause to take this position because the extensive research they conducted on the issue was supported by the issuance of a study provided by a firm with technical expertise in the subject matter.
Chief Counsel stated the cost segregation study in question “lacks the factual information upon which its conclusions are based.” Based on these deficiencies, it was not reasonable for the taxpayer to have relied on the cost segregation study as a defense to an accuracy-related penalty. Under section 6662, the negligence penalty is 20 percent of the underpayment in tax. This case emphasizes the importance of using a trustworthy cost segregation firm that has significant experience dealing with IRS audits.
This taxpayer was a partner in an entity that was previously examined for the issue of open air parking structures in which the IRS disallowed a 15 year recovery period. Under appeals, the IRS and the taxpayer reached a settlement on the issue. Under the more recent examination, the taxpayer placed a new parking structure into service and referred to it as Parking Garage. They hired a 3rd party firm to conduct a cost segregation study. The taxpayer received a memo which concludes that a parking structure generally does not meet the definition of a building. This suggestion is notwithstanding the discussion in the memo of the “function test” in section 1.48-1(e), which states that a structure is a “building if its purpose is, for example, to provide parking.” The memo acknowledges that in most cases, a parking structure will meet the function test since parking is one of the enumerated purposes in the regulation, but then incorrectly states that the appearance test is the decisive factor because a parking structure does not have walls or a roof, is open to the elements, and is not designed to provide shelter. The memo contains no discussion of the numerous cases that disregarded the appearance test over the function test, nor of the cases that have disregarded the argument that walls are necessary under the appearance test. Further, the applicable authorities are clear that a building is not required to have walls to enclose its space.
KBKG Analysis and Comments:
The taxpayer provides a number of additional arguments to defend their position and avoid penalties. However, I believe that the IRS is correct in their conclusion. The function test in section 1.48-1(e) provides that a building generally means a structure “the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores.” The purpose of the parking structure in this case is to provide parking so it clearly meets the function test.
In 2009, the IRS released a coordinated issue paper (LMSB4-0709-029) regarding the applicable recovery period under section 168(a) for open-air parking structures. The paper concludes that, based on Rev. Proc. 87-56 (Asset Class 00.3) and section 1.48-1(e), an open-air parking structure is a building and therefore has a 39-year depreciable life. Although this coordinate issue paper was released after the taxpayer filed its tax return, the cases and regulations upon which the coordinated issue paper is based existed well before taxpayer filed its tax return and is authority for purposes of evaluating reasonable basis.
This case emphasizes the risks of not using an established cost segregation firm with significant experience. Many careless cost segregation providers have taken the exact same position in their reports without advising their clients of the risk associated with it. The negligence penalty under Section 6662 explicitly excludes opinions rendered by tax professionals, so selecting the right cost segregation provider is critical.
The only way to ensure a cost segregation provider meets the highest industry standards is asking them if they are a “Certified cost segregation Professional” (CCSP) with the American Society of cost segregation Professionals. Any other credential is substandard. You should also request multiple references of clients that have gone through audit where IRS engineers actually reviewed the cost segregation study.
It’s not too late for KBKG to perform a Cost Segregation study for your or your client. Call us or fill out the Cost Segregation qualification form and answers a few questions to see if you can benefit from a study.
Author: Gian Pazzia, CCSP