The Risks of In-House Cost Segregation Studies

Some companies will try to save money by having cost segregation studies performed in-house by company employees rather than a professional in the industry. Unfortunately, this comes with a significant drawback—In-house studies are often viewed with more scrutiny by the IRS

Boddie-Noell Enterprises, Inc. v. the United States[1]

In 1996 Boddie-Noel Enterprises, Inc. sued the United States in federal court, seeking a refund of federal taxes they paid for the taxable years 1978 and 1979

Boddie-Noel Enterprises, Inc. owned and operated approximately 240 Hardee’s restaurants. They hired two employees to conduct the original cost segregation study. These in-house employees used an estimate of an existing study conducted by Hardee’s Food Systems, which indicated 24% of the assets qualified for ITC. Part of their methodology included sending questionnaires regarding costs to contractors. Unfortunately, after the fact, they didn’t keep those records.

Once the IRS examined the in-house employees’ methodology, they threw out the results of the study.

Off to Court, They Went!

The company took its case to court and hired an individual cost segregation practitioner to conduct studies on seven properties before trial. Unfortunately for Boddie-Noel Enterprises, Inc., the practitioner did not visit any of the sites.

Indirect costs were improperly allocated to the estimated take-offs (i.e., the allocation of excavation and other site work to electrical, HVAC, etc.)

They took some costs from estimating books and randomly assigned or adjusted others from the estimating books.

A Case Worth Reading

You can read the entire case transcript. Here is one exchange between the State’s defense attorney and the plaintiff’s witness

MR. FRAHM

Q Let’s return again to Boddie-Noell’s in-house study under which he had calculated his investment tax credit claim. After the claims were disallowed by Internal Revenue Service, you protested those claims, correct?

MR. JONES

A. That’s correct.

Q. And then subsequently, you filed the claims for refund?

A. That’s correct.

Q. And subsequently, you filed your suit?

A. That’s correct.

Q. And at the time of filing your suit, you were still relying on this in-house study, correct?

A. That’s correct.

Q. And for at least a year after the suit was filed, you were still relying on that in-house study to support your investment tax credit plan?

A. That’s correct.

Q. And then along came Mr. Hamilton, correct?

A. Well, we came along finding Mr. Hamilton.

Q. You found Mr. Hamilton, and now you are no longer relying on that in-house study?

A. That’s correct.

Q. So for 13 years approximately from the time construction commenced and was undertaken and was concluded until you filed suit for a year after suit, you were relying on information that you are no longer relying on today, correct?

A. That’s correct.

Q. It was only after I raised a question about the support for Boddie-Noell’s claims that you hired Mr. Hamilton, isn’t that correct?

A. In the course of our conversation, our goal early on was to be able to explain to you our methodology all the way throughout. It became early on that you were, that we were not being able to provide, based on our documentation or our in-house study, so we thought an expert study would provide that information and give you a little more comfort with the data.

Q. So, in plain language, I wasn’t buying your first implication, and now you came up with different information? Correct?

A. Well, in plainer language, we thought we would be able to give you a little bit better information that you could make a determination on.

Q. All right. So, in that sense, I prompted Mr. Hamilton’s study?

A. You prompted the study in reference to this case. Arthur Consulting had previously worked on studies for our restaurants which were a different concept.

The Results

After examining the methodology, the court stated, “The methodology employed by plaintiff…. was at best unusual.” They also noted that the results of the seven studies performed by the individual cost segregation practitioner appeared to be “based on after-the-fact speculations.” The court also found a lack of contemporaneous evidence supporting the corporations’ claims.

Other Important Points from This Case:

The court found that the following items didn’t qualify as a short life component:

·       Suspended Ceilings

·       The External Orange Roof Panels Specific to Hardee’s Design

·       HVAC

·       Drive-Up Window Units

Cost Segregation studies should not be taken lightly.

The IRS knows what separates a good study from a poor one. They view studies conducted by independent firms more favorably than those that are conducted in-house. Not just any independent cost segregation provider will do.

Before deciding on a provider, we recommend that you ask to see a sample of their study so you can compare the methodology used and the level of detail provided.

Because we meet or exceed IRS recommendations on how to perform our cost segregation studies, we are confident that our studies will stand up to any scrutiny. And if an IRS audit does occur, or if any questions are raised, we will defend our studies at no additional cost.

Request your free, no-obligation proposal today!


[1] Boddie-Noell Enterprises, Inc. v. United States, 36 Fed. Cl. 722 (1996)

Nov. 4, 1996 · United States Court of Federal Claims · No. 579-88T

36 Fed. Cl. 722