Introduction

Cost segregation is one of the most valuable tax planning strategies available to commercial real estate owners, allowing taxpayers to accelerate depreciation deductions by reclassifying building components from real property (39-year for commercial, 27.5-year for residential) to personal property (5, 7, or 15-year recovery periods). This comprehensive analysis examines key Tax Court cases that have shaped the landscape of cost segregation practice, with particular focus on cases similar to AmeriSouth vs. IRS.

AmeriSouth XXXII, Ltd. v. Commissioner (T.C. Memo. 2012-67)

The AmeriSouth case represents a landmark decision in cost segregation jurisprudence. In this case, AmeriSouth, a limited partnership, purchased an apartment complex in 2003 for $10.25 million and commissioned a cost-segregation study^[12]. The company then attempted to depreciate more than 1,000 building components over five- or 15-year spans, instead of the 27.5 years applicable to rental real estate under MACRS^[2].

The IRS audited and disallowed $1,079,751 in deductions for the years 2003-2005. When the case reached Tax Court, the court sided with the IRS on most items, holding that most components were structural components integral to the buildings' operation and maintenance, and therefore depreciable over the life of the building^[2][5].

The Tax Court's analysis in AmeriSouth established important principles for property categorization:

1. Components related to the operation or maintenance of a building are generally treated as structural components^[11].
2. Property that functions as an accessory to a business may qualify as personal property rather than a structural component^[11].
3. Permanence is an important but not always overriding factor in determining whether an item is a structural component^[11].

A few categories where the Tax Court sided with the taxpayer included clothes dryer vents, gate components, special outlets designed specifically for refrigerators, and surveillance components (camera and TV)^[2][11].

Peco Foods, Inc. v. Commissioner (T.C. Memo. 2012-18)

Another significant case is Peco Foods, Inc. v. Commissioner, where Peco Foods purchased poultry processing facilities in 1995 for over $27 million and in 1998 for almost $11 million^[6]. The purchase agreements included specific purchase price allocations for acquired assets, with most being listed as real property depreciable over 39 years using the straight-line method^[6].

In 1999, Peco commissioned a CPA firm to prepare a cost segregation study, which resulted in reallocation of the purchase price of buildings to shorter-lived assets. Peco then filed amended returns changing the depreciation method used on buildings, generating additional depreciation deductions of $5.3 million^[6].

The Tax Court held that Peco could not unilaterally change its original purchase price allocations made in the asset purchase agreements^[13]. The court noted that I.R.C. Sec. 1060(a) mandates that the allocations specified in the purchase contract control, and allowing subsequent changes could put the government in a "whipsaw" position^[6]. The court further clarified that the residual method is only available where contracting parties do not agree in writing to allocation of consideration of acquired assets^[6].

The 11th Circuit Court of Appeals affirmed the Tax Court's decision, reinforcing that taxpayers cannot unilaterally change purchase price allocations after the fact through cost segregation studies^[8].

Hospital Corporation of America v. Commissioner

The Hospital Corporation of America (HCA) case is another pivotal decision in cost segregation jurisprudence. In this case, the IRS determined that certain items were structural components of hospital facilities and not tangible personal property, resulting in longer depreciation periods^[7].

The case provided important guidance on distinguishing between real property structural components and tangible personal property in specialized facilities like hospitals. The court's analysis helped establish frameworks for determining when specialized systems and components can be classified as personal property despite being attached to or housed within real property structures.

West Covina Motors, Inc. v. Commissioner (T.C. Memo. 2009-291)

The West Covina Motors case, while not primarily about cost segregation, established important principles regarding asset allocation that impact cost segregation studies. This case is often cited in relation to the Peco Foods case regarding when the residual method can be applied to asset allocations^[6].

The case addressed various tax issues including inventory valuation, deductibility of legal fees, and accuracy-related penalties. The court's analysis provides guidance on substantiation requirements and the burden of proof in tax matters related to asset valuation^[10].

Cole v. Commissioner 871 F.2d 64 (7th Cir. 1989)

While not directly about cost segregation, the Cole v. Commissioner case addresses important principles regarding burden of proof in establishing asset valuation and depreciation. The case involved the disallowance of a bad debt deduction where taxpayers failed to prove that the debt became worthless in the tax years claimed^[3].

The court's analysis regarding substantiation requirements has implications for cost segregation studies, particularly regarding the burden of proving component values and appropriate classification.

Key Principles for Effective Cost Segregation

Based on these court cases, several principles emerge for effective and defensible cost segregation studies:

Conclusion

Cost segregation remains a powerful tax strategy when properly implemented with awareness of judicial precedents. The AmeriSouth case, along with Peco Foods, Hospital Corporation of America, and related decisions, provides valuable guidance on the boundaries and best practices for cost segregation studies.

For property owners considering cost segregation, these cases highlight the importance of proper methodology, documentation, and timing. For acquisitions, consideration of cost segregation should occur before finalizing purchase agreements to avoid limitations like those faced by Peco Foods.

When properly conducted according to established case law principles, cost segregation studies can provide significant tax benefits while withstanding IRS scrutiny, allowing property owners to maximize depreciation deductions and improve cash flow without undue tax risk.