Tax Court: Apartment Building Cost Segregation Largely Denied

This case arises from an unusual set of circumstances that include an aggressive cost segregation report and a “missing” taxpayer. The potentially avoidable determinations made in this case may concern many who specialize in property depreciation and cost segregation.

AmeriSouth XXXII was one of several apartment complexes owned by general partner AmeriSouth Texas and controlled by real estate investor Ruel Hamilton. AmeriSouth XXXII acquired a then 33-year old “garden-style” apartment complex in 2003. It promptly started a $2 million renovation and commissioned a cost segregation report. The report broke down the apartment complex (generally 27.5 year property) into over 1000 parts and moved several items into 5 year and 15 year property classifications for depreciation purposes. The changes substantially accelerated AmeriSouth’s depreciation expense on the property. AmeriSouth XXXII reported depreciation expense of $632,674 in 2003, $1,578,212 in 2004, and $818,143 in 2005. Under examination the IRS adjusted the depreciation expense in each year by $314,996, $508,977, and $255,778, respectively. That is the aggressive cost segregation study.

The missing client is more unusual. Either very near or during the time the case went to trial, AmeriSouth Texas and Mr. Hamilton sold the apartment complex held by AmeriSouth XXXII and decided to abandon its defense of the claimed depreciation. It did this by refusing to respond to communications from the Tax Court, IRS Counsel and its own lawyers, even as they were litigating the case at a Buffalo trial session. After an extension of time and several attempts to reestablish communication, the litigation team requested permission to withdraw from the matter prior to post-trial briefings. The court allowed the attorneys to withdraw but there is little question that the lack of post-trial briefing did not benefit the taxpayer and resulted in several of the conclusions reached by the court. That is the missing taxpayer.

Before we get to the court’s determinations, there is one more thing to cover. This case, AmeriSouth XXXII v. Commissioner, is a Memorandum Opinion of the Tax Court heard and authored by Judge Mark V. Holmes. As experienced observers know, depreciation cases are always fact intensive and rarely result in new legal conclusions. Thus, they are often not published as official reports of the Tax Court, i.e., division or conference opinions. Rather, depreciation cases are often disposed of, as this case was, in memorandum opinions where the emphasis is on the application of well established law to the particular facts of the case.

Memorandum opinions are not published in the official Tax Court Reports and have limited, if any, legal precedent. However, all memorandum opinions since 1995 are published on the U.S. Tax Court website and have been published in print by various legal publishing houses for decades. These opinions establish the application of settled law in certain factual circumstances. While many will insist, correctly, that memorandum opinions are not legal precedents they nonetheless are important guideposts for the court on factual matters. When on point, these cases are often followed by the Tax Court when similar facts reappear before the court (presumably in order to create a pattern of consistency and predictability for taxpayers). As further evidence of the relative importance of memorandum opinions, please consider that the court recently announced a uniform method for spot-citing memorandum opinions and will adopt that method in its own opinions beginning on August 1, 2012. In short, observers should not be surprised if the same determinations made on specific items of property in this case are cited in future decisions of the court. You can also almost certainly expect to see revenue agents relying on these determinations to make adjustments under examination.

Given all of that, where did Judge Holmes come down on the reclassified items claimed by the taxpayers? The list of reclassed items in this case is long, and as the judge quipped in the opinion, “[t]he details of depreciation spur many to more interesting pastures.” Accordingly, the entire 61-page opinion is included below for those who wish to sift through the details.

Highlights include wins for the taxpayer on the water-distribution system, the underground portion of “site electric”, and the gas lines (once it reached the apartments). However, the taxpayer won these issues because the Commissioner did not raise them until trial and thus bore the burden of proof, which he did not carry. Judge Holmes also allowed the taxpayers to depreciate electrical outlets located in the apartments to service refrigerators, stoves and laundry machines over 5 years under the rationale that they were not structural components, i.e. depreciable over the same 27.5 year period as the apartment building, but instead were personal property which served a specific piece of equipment. See generally, Hosp. Corp. of Am. v. Commissioner, 109 T.C. 21, 54-55 (1997). The Commissioner won nearly every other item claimed by AmeriSouth including some that may surprise practitioners who specialize in this area such as site preparation, HVAC and sanitary sewer.

Read the entire opinion here:
AmeriSouth XXXII v. Commissioner, TC Memo. 2012-67