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Navigating an IRS Cost Segregation Audit: Defending Your 5-Year Property Classifications

Aug 15, 2025

When an IRS audit targets your cost segregation study, the stakes are high. We’ve seen two aggressive tactics gaining traction:

  1. Disallowing 5-year treatment for kitchen assets like cabinets, countertops, and dedicated electrical/plumbing
  2. Blanket recharacterization of assets to 27.5-year property after a related-party property transfer

The good news? You can fight back — and win — by grounding your defense in Tax Court precedent, the IRS’s own Cost Segregation Audit Techniques Guide, and a solid engineering-based study.

Key Takeaway

  • Kitchen components can be classified as §1245 personal property with a 5-year recovery period under strong precedents (Whiteco, HCA).
  • Related-party property transfers do not automatically reset depreciation classifications.
  • A properly engineered cost segregation study is your most powerful audit defense.

Table of Contents

Challenge #1: IRS Disallowance of Kitchen Components

Auditors often argue that kitchen cabinets, countertops, and dedicated utilities are structural components (§1250 property) and must be depreciated over 27.5 years.

The IRS’s Flawed Argument: AmeriSouth

The IRS frequently cites AmeriSouth XXXII, Ltd. v. Commissioner, T.C. Memo 2012-67. But:

  • No Precedential Value — As a Tax Court Memorandum, it doesn’t carry the same weight as a published decision. The taxpayer abandoned the case, so the IRS’s position went unchallenged.
  • Weak Factual Context — No trial, no taxpayer evidence, no thorough record.

You can verify this in the U.S. Tax Court’s official case database.

Stronger Defense: Whiteco, HCA & the ATG

Whiteco Industries v. Commissioner — Created the Permanency Test to determine if an asset is easily removable, designed for relocation, or serves a specialized function. Many modern kitchen components meet these criteria.

Hospital Corporation of America (HCA) — Confirmed that assets serving specific business functions qualify for shorter depreciable lives. This includes dedicated wiring and plumbing for ovens, dishwashers, or commercial refrigerators.

IRS Cost Segregation ATG — Even the IRS acknowledges that dedicated utility systems can be classified as 5-year property under a functional allocation approach.

🔗 Learn more about How the ASUIP Tests Help Real Estate Investors Maximize Tax Savings Through Cost Segregation

Challenge #2: Asset Reclassification After Property Transfer

Some auditors attempt to reset all depreciation to 27.5 years after a property is transferred between related entities.

Why the IRS’s Position Lacks Merit

  • Depreciation Travels with Basis — The IRS has no blanket rule resetting recovery periods upon transfer without a change in use.
  • Facts & Circumstances ControlHCA confirms classification depends on asset use, not ownership changes.
  • Change in Accounting Method Issues — Forcing reclassification without cause may violate Rev. Proc. 2012-20, which generally requires filing Form 3115.

🔗 See our study on defending cost segregation after property transfers

Final Thoughts & Next Steps

When you’re in an IRS cost segregation audit:

  • Anchor your defense in Whiteco, HCA, and the IRS ATG
  • Document every asset with engineering evidence
  • Push back against weak precedent like AmeriSouth

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