Understanding Audit Risk for Cost Segregation Studies
Cost segregation studies conducted according to IRS guidelines face low audit risk when properly documented. The IRS has issued Cost Segregation Audit Techniques Guide that establishes standards for acceptable studies, and studies meeting these standards typically withstand examination without adjustment.
Multi-family properties undergo cost segregation frequently enough that IRS examiners are familiar with typical component allocations. Studies showing reasonable percentages for accelerated depreciation based on property characteristics generally do not attract scrutiny unless methodology appears flawed.
Audit risk increases when studies show unusually high accelerated depreciation percentages, lack engineering-based analysis, or fail to document the methodology adequately. Working with experienced cost segregation firms that follow IRS guidelines minimizes these risks.
The statute of limitations for IRS examination typically extends three years from filing. Maintaining study documentation including engineering reports, photographs, cost records, and supporting calculations throughout this period ensures you can defend your position if questioned.
Documentation Required for Audit Defense
A detailed engineering report forms the foundation of audit defense. This report should identify each component reclassified, explain the methodology for cost allocation, reference applicable tax authority, and include preparer credentials. Reports lacking this detail may not withstand examination.
Photographs documenting property conditions at the time of study support component identification. Interior and exterior photos showing items classified as personal property or land improvements provide visual evidence of study conclusions. Comprehensive photographic documentation is standard practice for quality cost segregation firms.
Cost records including construction contracts, invoices, payment applications, and change orders support value allocations. When actual costs are available, they generally provide stronger support than estimated allocations. Maintaining organized cost documentation simplifies audit response.
Calculations supporting component allocations should be reproducible. Whether using actual costs, contractor estimates, or cost estimation manuals, the methodology must be documented clearly enough for an examiner to verify results. Black-box calculations that cannot be explained create audit vulnerability.
What Happens During a Cost Segregation Audit
IRS examination of cost segregation typically begins with information document requests seeking your study report, cost records, and supporting documentation. Responding promptly and completely with organized materials demonstrates professional preparation and often resolves examiner questions without further inquiry.
Examiners may request property inspections to verify components claimed in the study. If physical conditions match study documentation, inspections typically confirm rather than challenge your position. Significant discrepancies between study claims and observed conditions create problems.
Technical consultations with IRS engineering specialists may occur for complex properties or unusual claims. Having your cost segregation firm available to explain methodology and answer technical questions facilitates resolution. Studies conducted by experienced firms are designed to withstand this level of review.
Proposed adjustments, if any, should be carefully reviewed before agreeing. Not all proposed changes are correct, and you have the right to challenge positions where the examiner has erred. Your cost segregation firm and tax advisors can help evaluate proposed adjustments and develop responses.
How Goodlane Group Supports Audit Defense
Goodlane Group connects multi-family owners with cost segregation firms whose studies are designed for audit defense from the start. Our network includes firms with track records of successful examinations and studies that consistently meet IRS Audit Techniques Guide standards.
We help you understand and maintain the documentation needed for potential audit response. Proper record retention from the time of study ensures you have necessary materials available if questions arise years later.
If examination occurs, Goodlane Group coordinates between your tax advisors and the cost segregation firm to develop response strategies. We help ensure technical questions reach appropriate experts and that responses address examiner concerns effectively.
Our ongoing relationship with cost segregation firms means assistance remains available even years after your study. When audit questions arise, we facilitate access to original study preparers and their supporting documentation to defend your position.