David Moore with Equity Advantage asks the expert Jonathan Frizzell with CBRE about cost segregation. Understand how cost segregation works and whether a cost segregation study might serve as an audit trigger for the IRS. Get the expert advice you need to protect your investments.
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Will a Cost Segregation Study Trigger an Audit?
David Moore: I always jokingly say about tax law that nothing is black and white. It’s all gray. Rarely is there something where we can or can’t do something; it’s a matter of how we’re going to get it done. With that said, have you had clients audited, and what kind of response has occurred if they have been, or what actually flagged the audit? Was it the cost seg? Do you see cost seg as an audit trigger?
Jonathan Frizzell: The answer is absolutely not. There is an unfounded belief out there that a cost seg study with a catch-up study and a 3115 IRS form will trigger an audit. Throughout my almost 13 years of service and the hundreds of studies I’ve personally delivered, we have never been audited. I’ve known of clients that have been audited that have had a cost seg study. But it was never because of the cost seg study. It was something else in their business or their personal tax return. Also, it’s important to note that if you have a high-quality cost seg provider that will defend it to the bitter end, there should be no problem at all whatsoever.
David Moore: So you’re saying to always deal with a professional and not somebody conducting a side business.
Jonathan Frizzell: Yes, deal with a professional. You don’t want somebody working in their kitchen, that’s for sure.
David Moore: If somebody is audited, is this something that the service is all in on? What should somebody expect?
Jonathan Frizzell: First of all, it’s an unlikely event that they are going to be audited. We’re looking at anywhere from a 1 to 1.5 percent of those that have had a cost seg study performed on their commercial property being audited.
David Moore: But the cost seg is not the trigger for the audit?
Jonathan Frizzell: It’s not the trigger. That is never the study. It’s something else in their file, 99.9 percent of the time. Then they happen to see that there has been a cost seg study been performed on that property. But to my knowledge, and I say this with certainty, I’ve never been audited in any of the studies that I’ve delivered. And anybody that I’ve worked with, the actual engineers, they’ve all won. They’ve all won-
David Moore: You mentioned that one of your coworkers had somebody audited.
Jonathan Frizzell: Yes. We usually give about 40 hours at no cost. If we have to travel, there might be a charge on that. But we try to give a minimum of 40 hours. I can sweeten it by doubling it, but 40 hours is plenty.
David Moore: So 40 hours of defense?
Jonathan Frizzell: Up to 40 hours of defense, audit support.
David Moore: But you just don’t have to do it very often.
Jonathan Frizzell: No, I don’t have to do it at all. Like I said, I’ve delivered several hundreds of studies, and I have not had a client audited—and I know my clients personally, so I would know about it. Again, audits are usually because of something else in the file, not because of the cost seg study.
David Moore: It’s really about doing good work, right?
Jonathan Frizzell: I do the on-sites, or OSRs, on-site reviews, on the building. Right now it’s not a great use of my time, but I learned a lot. But it’s important that the project manager or the engineer that does the on-site on the subject property takes the time out to document the improvements. When you get into retail and office, you want to treat each suite as a separate unit of property. You don’t want to use broad strokes and try to cut corners and get done. You want to go in right to come out right. It’s very important that when your project manager and engineer do the on-site, they visit every suite, occupied or unoccupied. That’s where the value is.
Jonathan Frizzell: It’s amazing among retail and office buildings. The truth of the matter is not all suites and units are created equal. They’re all different. That’s where the value is. Then when they bring back the pictures and all the documentation, that’s the second part of where the good work starts and ends.
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If you have questions about cost segregation, you can contact Jonathan directly at jonathan.frizzell@CBRE.com or by phone at 206-399-7769.