The Gold Standard Cost Segregation Approach

By: Lee Shreve

When choosing to have a cost segregation study performed on your commercial or income-producing building, what is your deciding factor in who becomes your cost segregation provider? Is it the price the company will charge for completing the study? Is it the number of years the company has been in business or the studies the company has completed?

When deciding on the right company, these are significant considerations, but did you consider the method of practice your potential provider uses? Under Chapter 3 of the Cost Segregation Audit Techniques Guide, there are six cost segregation approaches. However, all approaches are not created equal.

How do you decide which approach is the best? Below is a summary of the six cost segregation approaches:

• First Approach: Detailed Engineering from Actual Cost Records
  • Uses actual cost information from construction and accounting records
  • Construction documentation used to determine unit costs
  • A 10-step process is followed that includes a site visit
  • The most systematic and accurate approach
• Second Approach:  Detailed Engineering with Cost Estimates
  • Costs are estimated rather than using actual costs.
  • Used when cost records are not available
  • Additional steps are taken to determine the values of assets
  • This approach is methodical and relies on solid documentation
• Third Approach: Survey
  • For newly constructed property
  • Contractors provide information on the cost of specific assets that they installed
  • These costs are used in one of the engineering approaches
  • Allocations may be reliable if the contractor provides actual cost data
  • If costs are obtained from other projects, the data may not be reliable.
  • Use caution to ensure the total allocated costs do not exceed the actual project cost.
• Fourth Approach: Residual Estimation
  • Only short-lived assets (5- or 7-year) are identified
  • Short-lived asset costs are subtracted from total project cost, and the remaining is assigned to the building
  • A simpler approach, but less accurate; can produce skewed results
  • Does not reconcile project costs
• Fifth Approach: Sampling
  • Uses a template to analyze multiple facilities that are nearly identical
  • The costs derived are applied to the population on a percentage basis.
  • Accuracy is an issue; the sample may not be statistically valid
  • Factors such as variations in building codes, location, and material and labor costs make it difficult to create an appropriate model.
• Sixth Approach: Rule of Thumb
  • Little or no documentation is used.
  • Based on the preparer’s industry experience
  • This approach should be used with caution.

If you get down this far on the list, you have read Chapter 3 and now understand why the only choice is the Gold Standard engineering-based approach.