By: Andrew Szerletich – Project Engineer
When discussing what makes a quality cost segregation study, the IRS lists the first element as “Preparation by an Individual with Expertise and Experience”, and further elaborates this by stating “In general, a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background.” This is because as engineers (particularly Civil and Construction Engineers) we are taught in school and through our practice about the construction process. We understand how building components work with each other to produce a quality facility, and what component specifications are required for a given task. For example; what electrical amperage would be required for a given facility? What would be its needed airflow capabilities? What is a load bearing system vs one solely for aesthetics?
Another important characteristic desired by the IRS is that the preparer has “experience in cost estimating and allocation,”. As engineers, we are also taught in both school and in our practice to come up with the “most economical” option for our designs. This involves comparing the cost of two or more options with their respective outcomes and determining the best course of action for the money. By doing this we gain an understanding of estimating and calculating the costs of our designs, which translates to being able to accurately estimate the costs of individual components in the cost segregation process.
In the cost segregation study, we identify the costs for ALL the facility components; not just the components that are being accelerated as a result. This ensures an accurate cost for everything, as well as eliminates several areas of potential confusion during an audit. The process most commonly used involves calculating the engineering take-off costs for components, and subsequently subtracting these costs from the larger division of costs. This is referred to as the “Residual Method” and is typically has cost data backed up by publication documentation for various components. Another common method used in these take-offs, is called the “Rule of Thumb” and it draws heavily from the individual’s years of experience in the field to determine a rough cost for varying components, while providing little documentation to back up that data. To negate many problems, a hybrid of the two methods is typically the best course of action; using the residual method to calculate the ‘base’ cost of all the components, and then looking over the whole through the eyes of the rule of thumb method to check the accuracy.
For example: Let’s assume a project where the total heating/ventilation/air conditioning (HVAC) costs have been given by the contractor as $39,000 for a small car dealership expansion. Using the residual method, we calculate the take-offs for the vehicle monoxide systems to be $32,000; leaving just $7,000 for the air conditioning and heating of the new expansion. By using our experience, we can determine that is an unreasonably low cost for the general heating and A.C., so it prompts further investigation into the cost structure to determine the best course of action.
This is just one of the many ways that an engineer has the qualifications, skills, and the years of technical training necessary to perform a quality cost segregation study that will hold up against any potential IRS audit.