Detailed Cost Segregation Engineering Approach From Actual Cost Records:

The detailed engineering approach from actual cost records, or "detailed cost approach", uses costs from contemporaneous construction and accounting records.  In general, it is the most methodical and accurate approach, relying on solid documentation and minimal estimation.  Construction-based documentation, such as blueprints, specifications, contracts, job reports, change orders, payment requests, and invoices, are used to determine unit costs.  The use of actual cost records contributes to the overall accuracy of cost allocations, although issues may still arise as to the classification of specific assets.

This approach is generally applied only to new construction, where detailed cost records are available.  For used or acquired property and for new projects where original construction documents are not available, an alternative approach (e.g., the "detailed engineering cost estimate approach") may be more appropriate.

The detailed cost approach typically includes the following activities:

1) Identify the specific project/assets that will be analyzed.

2) Obtain a complete listing of all project costs and substantiate the total project costs.

3) Inspect the facility to determine the nature of the project and its intended use.

4) Photograph specific property items for reference.  Request previous site photographs that illustrate the construction progress as well as the condition of the property before the project began. 

5) Review "as-built" blueprints, specifications, contracts, bid documents, contractor pay requests, and other construction documentation.

6) Identify and assign specific project items to property classes (e.g., land, land improvements, building, equipment, furniture and fixtures, and other items of tangible personal property).

7) Prepare quantitative "take-offs" for all materials and use payment records to compute unit costs.

8) Apply unit costs to each project component to determine its total cost.  Reconcile total costs obtained from quantitative take-offs to total actual costs.

9) Allocate indirect costs, such as architectural fees, engineering fees, and permits, to appropriate assets.

10) Group project items with similar class lives and placed-in-service dates to compute depreciation.

The detailed cost approach is the most time consuming method and generally provides the most accurate cost allocations.  However, the examiner should recognize that the proper classification and costs of § 1245 property could still be an issue with this method. 1

Detailed Cost Segregation Engineering Cost Estimate Approach:

The detailed engineering cost estimate approach (or detailed estimate approach) is similar to the detailed cost approach.  The difference is that the detailed estimate approach estimates costs, rather than using actual costs. This approach is used when cost records are not available or for an acquisition when the purchase price must be allocated.

The detailed estimate approach is methodical, relying on solid documentation and utilizing construction-based documents such as blueprints, specifications, contracts, job reports, change orders, payment requests, invoices, appraisals, etc.  When estimates are required, they are based on costing data, either from contractors or from reliable published sources (e.g., R. S. Means or Marshall Valuation Service).  The sources of estimating data are clearly referenced, including identification of the specific volume, page, and item number.  Further, the same estimating techniques and unit cost data sources are used for all of the items that comprise the actual cost.

In essence, the steps for this approach are the same as the detailed cost approach, except for Step 7 (in which costs come from contractor estimates or estimating guides).  However, if detailed cost estimates are prepared by qualified individuals, and the estimates are reconciled to actual costs, then reasonably-accurate cost allocations are possible. 2

 1-2 Internal Revenue Service, Cost Segregation Audit Techniques Guide, Chapter 3 Cost Segregation Methodologies(accessed January 2, 2008); available from http://www.irs.gov/businesses/article/0,,id=135052,00.html#8.