The Tax Cuts and Jobs Act Gives Cost Segregation Studies New Life Michael F

The Tax Cuts and Jobs Act Gives Cost Segregation Studies New Life Michael F. Lynch, Nicholas C. Lynch, and David B. Casten*

A cost segregation study allows taxpayers to recover certain costs ordinarily classifi ed as real property over shorter cost recovery periods applicable to personal property. By recovering costs faster for tax purposes, taxpayers can accelerate tax benefi ts and enhance cash fl ows. The Tax Cuts and Jobs Act of 2017 has increased the benefi ts of a cost segregation study. However, the IRS will scrutinize aggressive cost reclassifi cations. Those inter- ested in performing cost segregation studies should be knowledge- able about the advantages and pitfalls of this tax-saving, cash-fl ow generating tool under the new tax law.

Introduction As a result of the Tax Cuts and Jobs Act (TCJA) of 2017,1 investors in residential and non-residential real estate property have more reason than ever to engage in a cost segregation study. A cost segregation study is an engineering or cost exercise the goal of which is to identify assets that qualify for accelerated deductions under the new tax law. The purpose of a cost segregation study is to identify costs commonly associated with land and buildings that may properly be classifi ed as other than real property for tax purposes. The deferred tax created by properly reclassifying portions of land and building costs as land improvements or tangible personal property, which can be depreciated over much shorter periods for federal (and where applicable, state) income tax purposes, results in signifi cant cash fl ow savings.

* Michael F. Lynch, J.D., C.P.A., is a Professor of Tax Accounting and the Director of Graduate Tax Studies at Bryant University in Smithfi eld, RI. He is also a practicing attorney in Providence, RI. Nicholas C. Lynch, Ph.D., is a Professor of Accountancy at California State University, Chico. Professor Lynch has a background in public accounting with a full service advisory fi rm. David B. Casten, J.D., LL.M., C.P.A., is a practicing attorney and C.P.A. in Providence, RI. He is a retired partner of KPMG LLP and an Adjunct Professor of Law at Boston University School of Law as well as a member of the accounting faculty at Bryant University in Smithfi eld, RI. The authors can be reached at [email protected], nclynch@ csuchico.edu, and [email protected], respectively. 1 P.L. 115-97, 131 Stat. 2054.

47 48 JOURNAL OF TAXATION OF INVESTMENTS

Cost segregation studies indeed are increasing in use as more and more investors, attorneys, CPAs, and their clients become familiar with them. Tax- payers should take necessary steps to ensure that the study is performed properly, which includes hiring a qualifi ed team of cost segregation professionals comprising experienced appraisers, engineers, architects, cost estimators, and tax professionals who follow Internal Revenue Service (IRS) guidelines. Cost segregation studies can be performed on any residential or non- residential depreciable property that is constructed, purchased, improved, or inherited. The study is easier to accomplish and more benefi cial if employed during the planning phase of construction. A cost segregation study enables taxpayers with current or planned investments in real estate to realize signifi - cant increases in cash fl ows and tax savings over multiple periods. The TCJA has greatly enhanced the depreciation deduction benefi ts of a cost segregation study, further increasing its value. Cost segregation studies do have their risks, however. There are cases where the IRS and the courts have levied penalties against taxpayers for taking an overly aggressive stance in the classifi cation or reclassifi cation of costs. Those seeking to perform a cost segregation study should be knowl- edgeable about the advantages and pitfalls of this tax-saving, cash fl ow generating tool under the new tax law. This article reviews the concept of cost segregation and provides an in-depth analysis of the enhanced depreciation deductions available under the new tax law, including new bonus depreciation rules and the expanded use of Section 179.2 A detailed discussion of what the IRS expects from a quality cost segregation report follows. Finally, the article analyzes the penalties imposed on persons who ignore the IRS guidelines and prepare a cost segregation report that results in the understatement of tax liability, and then recommends how to avoid those penalties.

Why Perform a Cost Segregation Study? Potential for Faster Depreciation. Cost segregation studies provide value by properly classifying property costs that would either not be depreciable if included in the cost of land or be depreciated over long periods of time (27.5 years for residential property and 39 years for non-residential property) if included in the cost of a building. These reclassiﬁ ed costs, referred to as land improvements or non-structural building elements, are depreciated over much shorter time periods: three, ﬁ ve, seven, 10, 15, or 20 years under the

2 All references to “Sections” are to the Internal Revenue Code of 1986 (the “Code”) as amended, unless otherwise indicated. COST SEGREGATION STUDIES 49

Modiﬁ ed Accelerated Cost Recovery System (MACRS).3 The accelerated depreciation offered through MACRS results in lower taxable income and net present value cash ﬂ ow savings, making cost segregation studies a desir- able value-creating tool.4

Liberalized Bonus Depreciation Rules. The value of a cost segregation study is made greater by the liberalized cost recovery provisions included in the TCJA. The new tax law allows 100 percent bonus depreciation for qualifying property with a recovery period of 20 years or less under MACRS, provided it is acquired and placed in service after September 27, 2017.5 The TCJA also expanded the deﬁ nition of qualifying property to include used property.6 Bonus depreciation now applies to used property as long as it was never used by the taxpayer before acquiring it.

Qualiﬁ cation Requirements. In order to qualify, all of the following must apply:

• Neither the taxpayer nor its predecessor used the property at any time before acquiring it; • The taxpayer did not acquire the property from a related party; • The taxpayer did not acquire the property from another member of a controlled group of corporations; • The taxpayer’s basis in the used property is not determined in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor; • The taxpayer’s basis in the used property is not determined under the provision for computing the basis of property acquired from a dece- dent; and • The cost of the used property eligible for bonus depreciation does not include the basis of property determined by reference to the basis of other property held at any time by the taxpayer (for example, for

3 Although Congress disallowed the use of component depreciation with the onset of MACRS in 1986, the decision in Hospital Corp. of America v. Comm’r, 109 TC 21 (1997), provided the legal basis for using a cost segregation study to classify or reclassify building components that do not meet the deﬁ nition of a “structural component” of a “building” as IRC § 1245 property. See also Whiteco Industries, Inc. v. Comm’r, 65 TC 664 (1975). 4 For a comprehensive analysis of the present value cash ﬂ ow tax savings that result from a cost segregation study, see Nicholas Lynch & Charles Pryor, “Cost Segregation Stud- ies: A Tax Saving Tool All Practitioners Should Be Ready to Offer,” 27(4) J. Tax’n Invs. 27 (Summer 2010). 5 IRC §§ 168(k)(1)(A), 168(k)(2)(A), 168(k)(6)(A). 6 IRC §§ 168(k)(2)(A)(ii), 168(k)(2)(E)(ii). 50 JOURNAL OF TAXATION OF INVESTMENTS

property “similar or related in service or use” acquired to replace property taken in an involuntary conversion7).

This is the fi rst time since the bonus depreciation provisions were passed in the Job Creation and Worker Assistance Act of 20028 that owners who acquire used property have the same tax benefi t as owners who acquire new property. This is a game changer for the cost segregation industry. Prior to the TCJA, taxpayers purchasing used property may have been dissuaded by the cost of a study. Congress has created a window of opportunity under which taxpayers purchasing commercial or residential real estate may now benefi t from a cost segregation study, by using the bonus depreciation rules, just as much as those who purchase new property. A building itself does not qualify for this new tax incentive. Under MACRS, non-residential real estate is still depreciated over a 39-year period and residential real estate over 27.5 years using the straight-line method. But MACRS property to which IRC Section 168 applies with a recovery period of 20 years or less will generally qualify.9

Phase-Out of Bonus Depreciation. Prior to the TCJA, bonus depreciation was limited to 50 percent of the cost of the qualiﬁ ed asset. The 100 percent deduction only applies to assets purchased before January 1, 2023. After 2022, the percentage is reduced as follows:

• 80 percent for property placed in service in 2023; • 60 percent for property placed in service in 2024; • 40 percent for property placed in service in 2025; and • 20 percent for property placed in service in 2026.

After 2026, bonus depreciation will no longer be allowed unless Congress decides to reinstate it.10

Option to Elect Out. Similar to the old law, a taxpayer can elect out of bonus depreciation for any class of property on an annual basis.11 The new

7 See IRC § 1033. 8 P.L. 107-147, 116 Stat. 21. 9 IRC § 168(k) contains the rules for bonus depreciation. IRC § 168(k)(2)(A)(i) defi nes qualifi ed property. 10 IRC § 168(k)(6)(A)(i). Historically, Congress has extended the bonus provisions when they were about to expire. It is probable that the provisions will be extended, in some form, before they reach zero percent. 11 IRC § 168(k)(7); Prop. Treas. Reg. § 1.168(k)-2(e)(1)(i). COST SEGREGATION STUDIES 51 act also allowed taxpayers to use the prior law’s 50 percent rate instead of the new 100 percent rate for the tax year that included September 27, 2017.12 This election cannot be used on a class-by-class basis. It must be made with respect to all qualifi ed property. Also, the qualifi ed property must be placed in service in the United States, providing an incentive for businesses to increase domestic investments.

Expanded Use of Section 179 The TCJA expanded Section 179, which allows for the immediate expensing of tangible personal property used in a trade or business. Starting in 2018, the infl ation adjusted deduction was increased from $510,000 to $1 million.13 The phase-out amount was also increased from $2 million in 2017 to $2.5 million in 2018.14 Section 179 is intended to benefi t small businesses only. If a company purchased more than $3.5 million of qualifi ed property in 2018, then no deduction was allowed. The phase-out adjustment and the $1 million limit are now permanent in the law. The amounts will be adjusted for infl ation starting in 2019. In 2019, the deduction is limited to $1.02 million, and the phase-out begins at $2.55 million.15

Broadened Defi nition of Qualifi ed Property. The TCJA broadened the defi nition of qualifi ed real property so that more building improvements will qualify to be expensed under Section 179. The defi nition of qualifi ed improvement property now encompasses any building improvement other than elevators, escalators, building enlargements, or changes to the internal structural framework of nonresidential buildings.16 Roofs, fi re and security systems, and HVAC equipment for use in non-residential real property qualify under Section 179 if acquired after the real property is placed in service.17 The defi nition of depreciable tangible property under Section 179 now includes property used to furnish lodging in residential property. However, the building itself and any improvements to it do not qualify. Thus, under the TCJA, items such as furniture, fi xtures, beds, refrigerators, stoves, lobby furniture, and offi ce equipment can now be expensed by owners of apartment

12 IRC § 168(k)(10)(A), as amended by 2017 TCJA § 13201(d). See also Prop. Treas. Reg. § 1.168(k)-2(e)(3). 13 IRC § 179(b)(1). 14 IRC § 179(b)(2). 15 Rev. Proc. 2018-57, 2018-49 IRB 827. 16 IRC § 179(d)(1)(B)(ii). 17 Id. 52 JOURNAL OF TAXATION OF INVESTMENTS complexes.18 Under prior law, these items could only be expensed by hotels where more than half of the living quarters were rented to transients for 30 days or less.

Limitations on Use of Section 179. Section 179 is only available for property that is used more than 50 percent of the time for business purposes.19 If the business use falls below the 50 percent threshold during the property’s recovery period, then some of the expensing is recaptured.20 Also, the Section 179 deduction cannot create a net operating loss (NOL).21 In other words, the deduction cannot exceed taxable income computed before taking into account the Section 179 deduction. Any expense in excess of the taxable income limita- tion can be carried forward indeﬁ nitely.22 Example 1 illustrates how this works:

Example 1: Assume that a business acquires $2.75 million of Sec- tion 179 property in 2019. Also assume that the business has taxable income of $600,000 without the Section 179 deduction. The maximum Section 179 deduction is $820,000 (i.e., $1.02 million minus $200,000; the excess of the purchases over $2.55 million). In 2019, the Section 179 deduction will be limited to $600,000, and the remaining expense of $220,000 ($820,000 minus $600,000) can be carried forward indeﬁ nitely.

As previously stated, qualifi ed improvement property related to non- residential realty may be expensed under Section 179, but it is not eligible for 100 percent bonus depreciation. It appears that Congress intended to assign a 15-year MACRS life to qualifi ed improvement property, which would have made it eligible for 100 percent bonus depreciation. A technical corrections act is necessary to fi x the statute.

Option to Elect Out. There are situations where a business may wish to elect to not currently expense purchases. Suppose that a business has an NOL that is about to expire. If a current depreciation deduction eliminates any current taxable income, then the beneﬁ ts of the NOL are wasted. Section 179(c) allows a taxpayer to make an annual election to expense a portion or all of an asset’s cost on a property-by-property basis. Bonus

18 Section 13101(c) of the TCJA amended the language in IRC § 179(d)(1) to allow property used predominately to furnish lodging or in conjunction with the furnishing of lodging as described in IRC § 50(b)(2) to be IRC § 179 property. See also Rev. Proc. 2019-08, 2019-03 IRB 347. 19 Treas. Reg. § 1.179-1(d)(1). 20 Treas. Reg. § 1.179-1(e)(1). 21 IRC § 179(d)(3). 22 IRC § 179(b)(3)(B). COST SEGREGATION STUDIES 53 depreciation applies to the full cost of an asset, and a taxpayer can only elect out for an entire class of property. Consider the scenarios in Examples 2 and 3:

Example 2:Assume that a business purchases a machine for $5,000. The asset has a ﬁ ve-year MACRS life. The asset quali- ﬁ es for immediate expensing under both Section 179 and the 100 percent bonus rules. Further assume that the business has $5,000 of taxable income (before depreciation) and an NOL carryforward of $800 that is about to expire. If the business elects 100 percent bonus depreciation, the taxable income will be zero, but the NOL will expire unused. Remember, the business must expense all or none of the cost of the asset under the bonus depreciation rules.

Example 3: However, if the business described in Example 2 elects out of bonus depreciation and elects Section 179 and expenses only $3,750 of the cost, then it will have taxable income of $1,250 before regular MACRS depreciation and the NOL. For fi ve-year MACRS property, the fi rst year’s depreciation would be $250 or 20 percent (half-year convention and fi ve-year life) of the $1,250 of the remaining cost. That would leave $1,000 of taxable income before the NOL. In this case, the full NOL carryforward of $800 is used and the business is left with future depreciation deductions of $1,000 ($5,000 - $3,750 - $250).

The TCJA amended Section 172(a) for tax years beginning after 2017. Under the new law, the NOL deduction is limited to 80 percent of taxable income, determined without regard to the NOL deduction.23 See Table 1.

Table 1: Advantage of Section 179 Taxable income before depreciation & NOL $5,000 Less: Section 179 expense (3,750) Taxable income before regular depreciation 1,250 Less: regular depreciation (250)* Taxable income before NOL 1,000 Less: NOL carryforward (800) Taxable income $200 *Remaining book value $1,250 × 20 percent per MACRS.

23 IRC § 172(a). Also, for tax years beginning after December 31, 2017, any unused NOLs may be carried forward indeﬁ nitely under IRC § 172(b)(1)(A). 54 JOURNAL OF TAXATION OF INVESTMENTS

There are times, however, when the 100 percent bonus depreciation rules are more advantageous than the Section 179 expensing election. The bonus election is not subject to the $1.02 million limit or the $2.55 million phase-out requirements. It is also not subject to the recapture provisions. And it is not limited to situations where the property is used more than 50 percent of the time for business purposes. The bonus deduction is available if there is any business use at all.

Key Elements of a Quality Cost Segregation Report It is established that a cost segregation study is a valuable engineering and accounting tool that can enable a qualifying taxpayer to realize signifi cant increases in cash fl ow and tax savings on residential or non-residential property over multiple time periods. However, the IRS is concerned that allocation of costs to assets with faster recovery periods be done in a manner that does not improperly reduce taxable income and tax liability. While the IRS does not prescribe how costs may be segregated, it has issued an Audit Techniques Guide that is instructive in helping taxpayers perform proper analysis and documentation to support segregation of costs.24 Spe- cifi cally, the Guide addresses how cost segregation studies should be prepared and how IRS agents will examine them. The Guide is not an offi cial IRS pro- nouncement and cannot be cited as precedent, but it obviously remains a valuable source of guidance. The IRS understands that there is no standard format for a cost segregation study. The Service agrees that some studies may be very brief while others may be quite voluminous and complex.25 However, the Ser- vice has stated that a cost segregation study and report should always (1) classify assets into property classes (e.g., land, land improvements, building, equipment, furniture, and fi xtures); (2) explain the rationale (including legal citations) for classifying assets as either Section 1245 or Section 1250 property; and (3) sub- stantiate the cost basis of each asset and reconcile total allocated costs to total actual costs. The Service defi nes a quality study as one that is both accurate and well-documented with regard to these three points. A quality study will expedite the Service’s review process and minimize the audit burden on all parties. The Guide lists the following 13 elements of a quality study:

1. Preparation by an individual with expertise and experience: There are no prescribed qualiﬁ cations for cost segregation preparers. The preparer should have knowledge of the construction process,

24 See IRS, Cost Segregation Audit Techniques Guide, available at https://www.irs.gov/ businesses/cost-segregation-audit-techniques-guide-table-of-contents. 25 See id., ch. 3 (“Cost Segregation Approaches”), available at https://www.irs.gov/ businesses/cost-segregation-audit-techniques-guide-chapter-3-cost-segregation-approaches. COST SEGREGATION STUDIES 55

cost estimating and allocation, and the tax law involving property classiﬁ cations for depreciation purposes.

2. Detailed description of the methodology: Chapter 3 of the Audit Guide discusses the most common approaches and methodolo- gies used in preparing a study. However, any format is acceptable as long as it is properly described.

3. Use of appropriate documentation: Documentation may vary but contemporaneous documentation is the most reliable and credible.

4. Interviews conducted with appropriate parties: Interviews with site managers, contractors, and subcontractors add credibility to the report.

5. Use of a common nomenclature: Preparers should not use “cre- ative” descriptions of assets that may disguise their true nature (e.g., an emergency exit sign termed a “decorative placard”).

6. Use of a standard numbering system: The use of a standard numbering system, such as the Construction Speciﬁ cation Institute (CSI) Master Format Division, is suggested.

7. Explanation of the legal analysis: The study should include a legal analysis, including relevant citations, to support its Section 1245 classiﬁ cations, especially if based on court decisions to which the Service has not acquiesced.

8. Determination of unit costs and engineering “take-offs”: Total project costs must be detailed. This process is referred to as engineering “take-offs.” The study must clearly explain and document the method used to assign costs to each asset.

9. Organization of assets into lists or groups: The study should list assets by their recovery periods and tie the assets to the taxpayer’s ﬁ xed asset ledger.

10. Reconciliation of total allocated costs to total actual costs: The same estimating technique should be used on all items that reconcile to a purchase price. Otherwise, cost discrepancies may occur.

11. Explanation of the treatment of indirect costs: Direct costs include labor and materials. Indirect costs or “allocables” must be described in detail. 56 JOURNAL OF TAXATION OF INVESTMENTS

12. Identifi cation and listing of Section 1245 property: The study should list any property (and amounts) that was originally classifi ed as Section 1250 property that is reclassifi ed as Section 1245 property.

13. Consideration of related aspects (e.g., Section 263A, Change in Accounting Method and Sampling Techniques): A change in a depreciation method, recovery period, or convention may consti- tute a change in accounting method that requires the consent of the Commissioner.26

A quality report should also contain the following:

1. A summary letter: The report should identify the preparer, the date of the study, the taxpayer, the property, and the classiﬁ cations such as land, land improvements, buildings, and personal property.

2. A narrative report: The narrative should discuss the regulations, rulings, and court cases that support classifying assets as Section 1245 property.

3. A schedule of assets: A schedule should be provided that ties the assets to the taxpayer’s depreciation records.

4. A schedule of direct and indirect costs: Indirect costs allocated to Section 1245 assets must be clearly identiﬁ ed and explained. Also, any costs subject to the uniform capitalization (UNICAP) rules of Section 263A must be addressed.

5. A schedule of property units and costs: This schedule both includes and describes property units and costs. It is the ﬁ nal prod- uct of the study and is used to compute depreciation.

6. Engineering procedures: The engineering procedures and methods used to deﬁ ne each property unit cost are described in this report.

7. A statement of assumptions and limiting conditions: The report should explain any special or limiting conditions that apply to the study.

26 Id., ch. 4 (“Principal Elements of a Quality Cost Segregation Study and Report”), available at https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-chapter-4- principal-elements-of-a-quality-cost-segregation-study-and-report. COST SEGREGATION STUDIES 57

8. A certiﬁ cation: The report should include the resume and state the credentials of the preparer and ascertain that the person who signed the report developed the analysis, opinions, and conclu- sions contained therein.

9. Exhibits: The report should include various exhibits, such as “Cli- ent Cost Sources” and the “Cost Source Reconciliation,” that show the accounting records the preparer relied on.27

Cost Segregation Risks and How to Avoid Them The IRS requires that the study be done by qualifi ed professionals. Simply segregating a project’s cost based on percentages is not allowed. Neither can a study be based on non-contemporaneous records, reconstructed data, taxpayer estimates, or assumptions that have no supporting records. Although some studies may be completed with little assistance, preparation of a “quality” study often requires the work of a team of engineers, architects, and accounting professionals. All cost segregation studies require proper documentation and should be performed by qualifi ed professionals. If a preparer fails to follow the guidance issued by the IRS, the Service has the power not only to penalize the taxpayer (client) for understating taxable income but also to severely penalize the study’s preparer for aiding and abetting in such an understatement. In a Chief Counsel Advice (CCA),28 the IRS ruled in 2017 that a tax consultant (not a preparer) who furnished clients with a depreciation analysis of their assets that front-loaded and mischaracterized components of 39-year depreciable property as property with a shorter fi ve-year life was liable under Section 6701 for aiding and abetting understatements of tax liability.

The Section 6701 Penalty. The Section 6701 penalty is imposed on any person who:

1. aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, afﬁ davit, claim or other document,

2. knows (or has reason to believe) that such portion will be used in con- nection with any material matter arising under the internal revenue laws, and

3. knows that such portion (if so used) would result in an understatement of the liability for tax of another person.

27 Id. 28 CCA 201805001 (Oct. 26, 2017). 58 JOURNAL OF TAXATION OF INVESTMENTS

The penalty is $1,000 per return and is limited to one penalty per person per period (or where there is no taxable period, any taxable event). However, if the return, affi davit, claim, or other document pertains to the tax liability of a corporation, then it is increased to $10,000. The penalty per person per period is mul- tiplied by the number of tax returns affected as well as the number of periods that an incorrect return was fi led. The total penalty amount can add up quickly. In the CCA, the IRS relied on Mitchell v. United States,29 a Ninth Circuit case decided in 1992, and concluded that, by furnishing his client a schedule that classifi ed certain real property as personal property, with a useful life of only fi ve years, Mitchell aided or assisted his client in the preparation of incorrect returns for fi ve different tax periods. As a result, he was liable for one penalty for each of the years for which a return was fi led with the IRS claiming an excessive deduction for depreciation. Thus, if his client was an individual taxpayer, the penalty would have been $5,000. If the client were a corporation, the penalty would have been $50,000.

Potential for, and Limits on, Multiple Penalties. The CCA also addressed the question as to how many Section 6701 penalties the tax consultant was liable for. Mitchell was a tax shelter organizer who reviewed and signed returns for an S corporation and K-1 forms for each of its 34 share- holders. The Mitchell court found that since all 34 investors incorporated the tax information contained on the K-1 supplied by Mitchell into his or her U.S. individual tax return, Mitchell aided in the preparation of 35 returns. Section 6701(b)(3) prevents the IRS from imposing separate Section 6701 penalties when a taxpayer prepares multiple documents in the same year for a client. In Mattingly v. United States,30 the Eighth Circuit held in 1991 that an individual who prepared 46 returns for taxable year 1983 with understatements of tax attributable to disallowed investment tax credits was subject to the Section 6701 penalty for each return but not for any carryover returns prepared for subsequent tax years. In Emanuel v. United States,31 a federal district court held in 1989 that the IRS violated Section 6701(b)(3). In that case, an individual prepared returns in 1982 containing incorrect investment tax credits. Some clients then ﬁ led Form 1045 in order to receive refunds on prior or subsequent returns. The Emanuel court stated that the IRS had violated Section 6701 by imposing penalties based on the Forms 1045 because they related to the year 1982.

Burden of Proof. Section 6703 states that the IRS has the burden of proof in assessing penalties under Section 6701. However, the question as

29 977 F2d 1318 (9th Cir. 1992). 30 924 F2d 785 (8th Circ. 1991). 31 705 F. Supp. 434 (N.D. Ill. 1989). COST SEGREGATION STUDIES 59 to what is the standard for the burden of proof is unresolved. Is the proper standard a “preponderance of the evidence,” which is easy for the government to prove, or “clear and convincing evidence,” which is difﬁ cult for the government to prove? Section 6701(f) states that the penalty can be imposed “whether or not the understatement is done with the knowledge or consent” of the taxpayer. Section 6701 does not use the word fraud or the phrase tax evasion. But the statute clearly says that the person aiding and abetting the taxpayer must know (or have reason to believe) that the document provided will result in an understatement of tax liability for another person.

Need for Taxpayer Diligence. Although prior case law may keep consultant/preparer penalties from becoming excessive in certain instances, taxpayers who rely on third parties for cost segregation studies are not immune when it comes to penalties for underpayment of tax. Therefore, taxpayers should ensure that they hire qualifi ed professionals to conduct a cost segregation study. The American Society of Cost Segregation Professionals (ASCSP) is the industry leader in cost segregation certifi cation. The ASCSP has its own Code of Ethics and Minimum Quality Standards to which members must adhere. The ASCSP offers two levels of membership: member and certifi ed member. Members must have a minimum of one year (at least 1,000 documented hours) of experience performing cost segregation studies and have passed the Member exam. Certifi ed members have a minimum of seven years (at least 7,000 documented hours) of experience, submit a sample cost segregation report, obtain the recommendation of two Certifi ed members, pass a phone interview, and pass the Certifi ed examination.32

Conclusion The TCJA has dramatically increased the demand for cost segregation studies. Investors planning on building or acquiring domestic real estate should engage the services of a reputable cost segregation specialist to help maxi- mize the tax benefi ts offered under the new tax law. The changes to Sec- tion 179 and the inclusion of used property for bonus depreciation purposes have greatly expanded the benefi ts of cost segregation studies. If properly executed, cost segregation studies can result in signifi cant tax savings and increases in cash fl ows. However, an overly aggressive study can result in substantial penalties. It is important that investors as well as tax advisors in the cost segregation market remain up to date on the latest regulatory guidelines and changes. It can be the difference between a high return on investment and a court hearing.

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