Tax Court Disallows Cost Segregation of Apartment Building Components

In a case exploring the extent of allowable cost segregation in depreciable rental real estate, the Tax Court held that all but a small handful of items identified by the building’s owner had to be depreciated over the life of the building (AmeriSouth XXXII, Ltd., T.C. Memo. 2012-67).

AmeriSouth, a limited partnership, bought an apartment complex in 2003 for $10.25 million. AmeriSouth commissioned a cost-segregation study and 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. Using its cost-segregation method, AmeriSouth deducted $3,029,029 for depreciation in the years 2003–2005.

The IRS audited the partnership under TEFRA and disagreed with AmeriSouth’s treatment of the components; it denied $1,079,751 in deductions for those years. The case ended up in Tax Court, where the IRS also argued that AmeriSouth was attempting to depreciate some assets it did not own.

About the time the case was tried, AmeriSouth sold the apartment complex and subsequently stopped responding to communications from the court, the IRS, and even its own attorneys. The court allowed the attorneys to withdraw from the case. When AmeriSouth failed to file a post-trial brief, the court could have dismissed the case entirely, but instead it decided the case, deeming any factual matters not contested to be conceded by AmeriSouth.

The court looked in depth at the components in each of the 12 categories AmeriSouth had identified for faster depreciation: site preparation and earthwork; water distribution system; sanitary-sewer system; gas line; site electric; special HVAC; special plumbing; special electric; finish carpentry; millwork; interior windows and mirrors; and special painting.

Based on its examination of the facts, the court sided with the IRS in all but a small handful of instances, holding that most components were structural components, integral to the buildings’ operation and maintenance, and therefore depreciable over the life of the building.

The only components AmeriSouth won on were clothes dryer vents; gate components; outlets and timers relating to watering of the grounds; surveillance components (camera and TV); refrigerator, stove, and washer/dryer outlets; and cable, telephone, and data outlets.