What the IRS Cost Segregation Audit Techniques Guide Expects

The IRS does not tell you how to prepare a cost segregation study. Its own guide says it “has not established any requirements or standards for the preparation of cost segregation studies.” What it does publish is the Cost Segregation Audit Techniques Guide (Pub 5653, revised February 2025), which tells examiners what a quality study looks like and where weak ones fail. In practice it is the specification every serious study is built to.

The 13 principal elements of a quality study

Chapter 4 lists them. In plain terms:

1. Prepared by someone with the right expertise: construction, cost estimating and tax law. The guide notes a study by a construction engineer is more reliable, and says a quality study identifies its preparer and credentials.
2. A detailed description of the methodology, step by step.
3. Appropriate documentation: the best available, with contemporaneous records most reliable. For new construction, drawings, specifications, AIA G701 to G704 pay applications, change orders and invoices. For acquired property, the purchase documents, an appropriate land value, and a site visit with photos.
4. Interviews with people who know the property, documented.
5. A common nomenclature that matches the drawings and pay applications.
6. A standard numbering system, such as CSI MasterFormat.
7. An explanation of the legal analysis, with citations, reconciling conflicting authorities.
8. Documented unit costs and quantity takeoffs, reconciled to the acquisition price or project cost.
9. Assets organized into lists or groups by recovery period, tied to the fixed-asset ledger.
10. Reconciliation of total allocated costs to total actual costs, listing separately acquired equipment so it is not counted twice.
11. An explanation of indirect costs and how each was allocated.
12. Identification of §1245 property, showing what moved out of §1250.
13. Related aspects considered: §263A capitalization, the accounting method change, and the validity of any sampling.

Chapter 4 also lists nine elements of a quality report, from the summary letter through the certification that the person who signed the report actually developed the analysis, to exhibits reconciling cost sources.

Six approaches, ranked

Chapter 3 describes six ways studies are prepared: a detailed engineering approach from actual cost records (the most accurate, for new construction), a detailed engineering cost estimate (for acquired property, citing the cost manual by volume, page and item), a survey or letter approach, residual estimation, sampling or modeling, and rules of thumb. The guide calls residual estimation less accurate and tells examiners to view rules of thumb with caution. It also says a pro-rata “step-up factor” that scales estimates to force them to match the purchase price is not an acceptable method.

The red flags examiners check

Chapter 5 gives examiners a list to look for: mixed recovery periods inside one unit of property; structural components classified as 5- or 7-year property; little or no land; creative names for ordinary components; double counting of separately purchased furniture and equipment; a standard percentage of electrical allocated to equipment; methods that ignore a prior straight-line election; wrong placed-in-service dates; and large look-back adjustments. It also tells examiners to closely scrutinize studies priced as a contingent fee and to request the engagement letter.

What examiners ask for

Chapter 6 sets out the standard information document requests: the study participants, the property, drawings, a copy of the study, the computations and formulas (including “a description of the software used”), and specific questions on specific items. A study’s workpapers should answer those requests before they are issued.

Two points often misstated

• Site visits. The guide recommends a field inspection for all quality studies and calls it critical for acquired property with limited drawings. It does not mention virtual or remote inspections. Photo or video walkthroughs are common practice for small, simple properties, but they are an industry practice, not something the guide endorses.
• Industry matrices. For retail, restaurants, residential rental property and several other industries, chapter 7 publishes classification matrices, and says that if a return is consistent with the matrix, examiners should not make adjustments. Some IRS positions are more conservative than common vendor practice: apartment kitchen cabinets are 27.5-year property, for example. Following the matrix is the strongest footing a classification can have.

What this means when you choose a study

Ask any provider how their study addresses each of the 13 elements, who the preparer is and what their credentials are, how they reconcile to your actual cost, how they value land, and whether the fee is fixed. Our studies are keyed to the 13 elements one for one, every classification cites its authority, and a CPA reviews and approves each study before it is issued. See cost segregation for CPA firms for the red-flag checklist in table form.

Sources

• IRS Pub 5653, Cost Segregation Audit Techniques Guide (rev. 2-2025): https://www.irs.gov/pub/irs-pdf/p5653.pdf
• ASCSP Minimum Quality Standards (industry standard aligned to the ATG): https://www.ascsp.org/minimum-quality-standards-publication