:: Add To Favorites :: Set As Homepage

 

:: Cost Segregation Audit Techniques Guide - Chapter 5 - Review And Examination Of A Cost Segregation Study   CHAPTER 5 - REVIEW AND EXAMINATION OF A COST SEGREGATION STUDY INTRODUCTION The preceding chapters described the legal framework for classifying assets ( Chapter 2), common methods used to segregate costs ( Chapter 3), and elements of a quality cost segregation study and report (Chapter 4). This chapter provides suggested audit steps for reviewing and examining a cost segregation study. The appropriate audit steps depend on the nature and size of the segregation project as well as on the overall quality of the study. Cost segregation is a factually intensive determination that is based on complex tax law and engineering analysis. While agents may be able to evaluate the adequacy of some cost segregation studies (e.g., smaller projects), other studies may require specialists with expertise, industry experience and specialized training. The Engineering Program in LMSB is the principal source of technical expertise for examining cost segregation studies. The Computer Audit Specialist (CAS) Program in LMSB is also available to provide assistance when a study is based on statistical sampling. Formal advice, using the referral process, should be solicited through the LMSB web site (IRWEB/LMSB/Field Specialists/, and select Engineers or CAS) and the Specialist Referral System (SRS). Informal advice is also available by contacting your local specialist group. The suggested audit steps are presented below in an outline format. In order to have a better understanding of these steps, examiners may want to refer to Appendix Chapter 6.6 for a brief overview of the construction process. While some steps will not apply to all studies, each step should be carefully considered before moving on to the next one. Review A Copy Of The Cost Segregation Study And Report Verify The Cost Basis And Reconcile Depreciation Records Conduct A Risk Analysis To Evaluate Audit Potential Interview The Preparer Inspect The Property Review And Verify The Classes of Property Perform A Cost Analysis A. Newly-Constructed Property B. Existing Property Review Sampling Techniques Consider IRC § 263A Consider Change In Accounting Method Research The Law, The Regulations And Appropriate Rulings Summarize The Findings And Discuss The Challenged Assets With The Taxpayer Prepare The Final Report Or The Notice Of Proposed Adjustments back to the top   STEPS FOR REVIEWING A COST SEGREGATION STUDY AND REPORT Review A Copy Of The Cost Segregation Study & Report If the taxpayer has claimed depreciation deductions based on a cost segregation study, the examiner should review and evaluate the study and report. Request a copy of the Cost Segregation Study/Report. Refer to the IDR Exhibits in Appendix Chapter 6.7 for suggested language. Request a copy of the Letter of Engagement to determine the scope of the study. Determine the Nature of the Fee Arrangement. Many firms charge a fee based primarily on the size of the project. Out-of-pocket expenditures are generally added to this cost. Some firms use contingency fees where cost is based primarily on the tax benefits received from a study. Contingency fee arrangements create the incentive to maximize § 1245 costs, usually through "aggressive" legal interpretations and/or by inappropriate cost or estimation techniques. Accordingly, examiners should closely scrutinize studies performed on contingency fees. Read the Entire Report. Evaluate the Study with respect to its depth, accuracy and methodology. What methodology was used (see Chapter 3)? How does the study and report compare to the quality elements described in Chapter 4? Determine the Cost Allocation Process and the Source of any Unit Costs. How were costs allocated? Were actual costs or estimates used? How were unit costs determined? Review the Property Units and the Types of Assets. Assets are generally classified into various units or groups of assets and are often listed in both a "Summary" and "Detail" format. The "Property Unit Summary" is a summary of the unit (asset) groupings by land, land improvements, 3-year, 5-year, 7-year, 10-year, 15-year, 20-year, 27.5-year and/or 39-year property. The "Property Unit Detail" is a detailed asset schedule within each unit (asset) grouping that describes the assets and shows their costs. An example of a unit grouping is "Kitchen Equipment--Plumbing". Within this grouping, the Property Unit Detail schedule might list the floor drain, grease trap, or sink. Abbreviated methodologies may not classify assets into property units. Nevertheless, assets still must be identified, supported and documented in a cost segregation report. Verify The Cost Basis And Reconcile Depreciation Records Examiners should reconcile the basis of property in a study to basis in the taxpayer's books and records. Request Detailed (Asset-by-Asset) Depreciation Schedules that tie to the return. Determine how the study assets are shown on the depreciation schedules. Review Tax Depreciation Schedules to verify that tax basis reconciles with the study; note any differences. Are fixtures, furnishings and equipment included in the study? Are they on other cost recovery schedules? Have these costs been duplicated? Request Prior Year Tax Depreciation Schedules that correspond to the study’s assets. Do these schedules reconcile to depreciation for prior year returns? Property reclassified to a shorter recovery period must be depreciated using the proper method pursuant to IRC § 168(b). For example, if straight-line depreciation was used for other property placed in service for a given recovery period during the same year that the reclassified assets were placed in service, then IRC 168(b)(3) requires that the reclassified assets must also be depreciated using the straight-line method. The election to use straight-line depreciation is irrevocable pursuant to IRC § 168(b)(5). Request Contemporaneous Documentation to Substantiate and Verify the Basis of Assets. Determine Whether Basis was Properly Allocated to land, non-depreciable land improvements (general land grading, off-site street improvements) and/or other property types aside from those considered by the study. Were any project costs allocated to land or land improvements? Many studies allocate almost all costs to building and personal property, instead of allocating appropriate amounts to land, land improvements, or other long-lived assets. In the case of acquired property, it is often appropriate to assign a large portion of an acquisition price to land, prior to allocating the remaining purchase price to other property. Conduct A Risk Analysis To Evaluate Audit Potential and Determine Audit Scope. Review the Descriptions in the Property Unit Detail Schedule to determine the type of property in each unit (or group). Review the Classification of Property Units and its reasonableness. Compare the Study’s Property Descriptions and Classifications To Revenue Procedure 87-56, 1987-2 C.B. 674. Are there any deviations that may indicate a potential audit issue? Can you identify specific assets that might need to be viewed during a tour of the projector facility? Common situations suggesting audit potential include the following: Mixed asset types in the same unit (or group). Building elements or leasehold improvements included in short-lived property units. Minimal or no dollar amounts assigned to land, non-depreciable land improvements, building, or other long-lived assets. Use of "creative" nomenclature or inconsistent titles and descriptions to disguise the true character of a property asset. Does the study nomenclature reflect the construction records and blueprints? Request Additional Information (as needed) to determine audit potential. Issue IDR's to determine the classification of items not readily understood (refer to Appendix Chapter 6.7 for suggested language). Request contemporaneous records (permits, design studies, contractor payment records, contracts, purchase orders, invoices) to verify the costs and descriptions of property as well as to ascertain their functional use. This will facilitate the determination of the proper asset classification pursuant to Revenue Procedure 87-56. For example, machinery located in a chemical plant is 5-year property instead of 7-year property if it meets the requirements of Asset Class 28.0 (refer to Appendix Chapter 6.3 for information on asset classes). Request the "Capital Expenditure Request" to verify project costs and identify related purchases (it may also help determine the intended use of the property). In some cases, it may be more appropriate for the preparer of the study to respond to the document requests. Supporting documents may include computer files, hardcopy files, plans, etc. A Computer Audit Specialist can assist in viewing computer files not ordinarily viewable on IRS computers. Summarize Your Preliminary Findings. Quantify the tax impact of potential audit issues, such as: The cost basis of items that are in question or dispute or are unsubstantiated. Assets that have been misclassified Double deductions for separately-acquired assets. The use of improper depreciation methods. The incorrect placed-in-service date. Large look-back computation (i.e., the study reflects a change in method of accounting, with the return reflecting a deduction for depreciation not deducted in prior years) Determine the Need for Specialists (e.g., Engineers and/or Computer Audit). Specialists may be required to assist in the examination of complex projects. It is important that specialists be involved in the audit as early as possible. Informal assistance may also be requested when needed. A study with significant tax impact generally requires the assistance of specialists. These studies will typically have a large number of assets or complex assets. A study that allocates estimated costs between § 1245 and § 1250 property (particularly electrical or plumbing component systems) typically requires the assistance of an Engineer. Engineers can provide the expertise needed for the proper development and resolution of the issue. Studies involving numerous assets or allocations may require the assistance of a Computer Audit Specialist (CAS) to process the data and/or evaluate any statistical sampling methods. Determine the Scope and Depth of Your Examination. Risk analysis is a subjective process based on the experience, knowledge and judgment of the examiner. Guidelines provided in the previous chapters will assist examiners in evaluating the overall accuracy and adequacy of a study as well as in determining audit potential and scope. Studies with little tax impact should be closed expeditiously. Studies with significant tax impact should be considered for additional review and examination and will generally require specialist assistance. Interview The Preparer Schedule an Interview with the Preparer. If possible, this should be completed before or contemporaneous with the on-site inspection (see Step 5). The interview should address the scope and assumptions of the study and any observations of the project or facilities. Possible interview questions include: Were the properties inspected at the time of the study? Were photographs and/or video media taken and/or relied upon in classifying property? Were sampling techniques used? What cost estimating guides were used? Where are the guides located (for purposes of verifying estimates)? What documentation was used to establish the cost basis and particular use of a property item? How was the cost of each property item identified, segregated, and classified? Where are the workpapers? Inspect the Property In general, the Service engineer (if assigned) is responsible for arranging the on-site inspection, which provides the opportunity to view the assets in question. Inspections also help identify underground utilities, off-site improvements and general grading costs that may have been misclassified as § 1245 or § 1250 property. Overall, the inspection provides information to assist in determining classifications of § 1245 and § 1250 property. Prior to Scheduling the Tour, Complete your Review of the Study in order to identify specific assets and concerns that require inspection. Prepare a List of Assets/Items that Warrant Inspection and provide it to the taxpayer beforehand. Ask additional questions and/or view additional property components during the tour as needed. Plan the Inspection to Minimize Time and Travel Costs. For cases involving multiple properties of similar character, consider inspecting only a representative number of properties or facilities. Take a Camera or Video Recorder (Camcorder) to record the condition of the property. Confirm beforehand that photography will be allowed/permissible. Request that the Property Manager/Maintenance Engineer be Available During the Tour. It is important that someone familiar with the physical attributes and workings of the property be available to answer questions and provide access to non-public areas. Request that the Preparer Attend the Tour if possible. He/she can identify the physical attributes of specific assets and explain how they were classified. Request Access to Plans, Drawings and Contract Documents that are located on-site. Prepare an IDR in duplicate so that any requested items received during the inspection can be noted and an acknowledgement copy of the IDR can be left with the taxpayer. back to the top   View the Project Site and Note Features that impact the cost allocations and property classifications. Consider the following points: Location - Record the address and locate it on a map for future reference. What is the character of the neighborhood and how does the location impact land value? Is there any other property for sale in the area? Note the real estate company name and the address of the property for future reference. Topography - Observe the topography and determine whether the land was initially hilly or low-lying. Did the project include the general grading of the land? Were large amounts of fill required in order to build? Site Conditions - Determine whether the project included the subdividing or rezoning of land. Did it require environmental or land use permits, or the construction of access roads? Were off-site improvements (e.g., streets, sidewalks, sewers, storm drains) constructed? Were any of these improvements dedicated to the local municipality? Condition of Property - Is the property new or old, worn or renovated? Were the materials modern or old? Project Records – Where are the original project records (e.g., drawing, plans, contracts, payment records) located? Ask for the names of employees who may have particular knowledge of the construction. Request interviews with such individuals as needed. Individual Assets - View each challenged asset to gain a thorough understanding of the facts and circumstances that affect its classification and cost. Ask the site manager how the facility is used and how individual assets operate. Cost Data - Discuss the methodology that was used to determine the cost of assets. Were standard cost guides used to estimate costs? Ask on-site maintenance and facility operations personnel about local construction and repair costs in order to verify the estimated costs in a study. Prepare Notes and Drawings for future reference. Obtain sufficient information to properly classify each challenged asset. When possible, obtain local cost data to verify estimates and cost allocations. Review And Verify The Classes Of Property Review the study again to determine whether property classifications are correct. Are Assets Classified into their Proper Groups, such as? Land Non-Depreciable Land Improvements (i.e., all off-site construction and general land grading expenses) Depreciable Land Improvements Buildings, Structural Components and Other § 1250 Property Office Furniture, Fixtures and Equipment Information Systems Building Systems (e.g., mechanical, electrical, plumbing) Process Systems (e.g., process piping) Non-Residential Real Property Other Miscellaneous Property Are Assets Assigned to the Proper Asset Class and Recovery Period? The classification of assets as either § 1245 or § 1250 property is a factually intensive determination with no bright line tests. Refer to Chapter 2, "Legal Framework" and to Appendix Chapter 6.4 for a summary of the pertinent law and judicial precedent with respect to the classification of property. Recovery periods are either specifically assigned by statute (IRC § 168 and the Regulations thereunder) or are determined pursuant to Revenue Procedure 87-56, 1987-2 C.B. 674. Refer to Appendix Chapter 6.3, "Depreciation Overview," for further information on recovery periods. Common Audit Issues A common issue is the allocation of specific components or a portion of a building system to § 1245 property. The issue is often the result of poor documentation and/or improper legal support. Example 1 Some studies may include a specific component of a building's electrical system (e.g., plug outlet, switch, branch circuit) as being allocable to the piece of tangible personal property that it supports (e.g., dishwasher, garbage disposal, etc.). Accordingly, the component item is treated as § 1245 property (7-year MACRS). However, if that same electrical component item can be used for other pieces of equipment, the Service examiner may consider it to be part of the building’s general electrical system. Accordingly, it would then be classified as part of the building as § 1250 property (39-year MACRS). back to the top Example 2 Some studies allocate a portion of the primary electrical feeder circuit that carries electricity to one specific item of equipment or machinery as § 1245 property. The use of a "standard" percentage of electrical costs is a common approach. However, in the Service’s view, these types of allocations should be based on usage or load studies designed to ascertain the percentage of electricity allocable to specific § 1245 property (as opposed to supporting the general function or maintenance of the building). Examiners can also check whether a company was reimbursed for the sales tax paid on electricity used in manufacturing; this information may provide insight as to the correct percentage. In summary, the examiner should conduct an in-depth analysis of the allocation and supporting documentation when a standard percentage is used. Example 3 Some taxpayers have filed claims based on a cost segregation study of leased property. Typically, leases were assigned to 39-year recovery property on the original returns. Subsequently, the taxpayer re-determines its allowable depreciation on the basis that the acquisition was for goodwill rather than for the lease. The benefit is a potential 15-year amortization of goodwill pursuant to IRC § 197 (if the acquisition otherwise qualifies under § 197). Examiners should closely scrutinize allocations of this type. List Assets into the Proper Asset Class and Recovery Period. back to the top   Perform A Cost Analysis Once proper classifications and recovery periods have been determined, the next step is to determine the costs allocable to individual assets. This determination will depend on whether the asset is newly constructed or is a purchased or existing facility. It is important to realize that cost determinations are very time consuming. Therefore, it is recommended that examiners determine that significant discrepancies exist, or are strongly suspected, before undertaking Steps 7A or 7B below. A. Cost Analysis Of Newly-Constructed Property Actual cost records should be available from the preparer, taxpayer, general contractor, and/or other third parties. Cost records should be requested for significant property items only. Gather Background Information. Secure total project costs by requesting information related to the construction project billings. Review construction drawings, blueprints and specifications. Blueprints and specifications identify property items, construction methods and locations of items within the structure. Review the "as-built" drawings if available (generally available from the taxpayer, architect, contractor, local building department, local fire department, or insurance carrier). Review the most "up-to-date" drawings as well. These drawings are typically found in the engineering or property manager’s office and can be accessed during the inspection. Request the building and occupancy permits, which can assist in establishing the placed in service date. Request photographs of the site showing the condition of the property before the project began. This will help determine whether significant site preparation or general grading costs were incurred. Request Contemporaneous Records to Substantiate the Cost Basis of Assets in the Study. Contract documents specify how payments are made and typically require payment requests to be broken down into individual items of property. The American Institute of Architects (AIA) Form G-702 is used to process payments on nearly all construction projects. This form requires contractors to break down their payment requests into amounts for each individual building system or trade (e.g., site preparation, grading, concrete, wood, electrical). Purchase orders and invoices are another source of cost data. Analyze the Total Project Costs. Review the Contractor’s Requests for Payment in AIA Forms G-702 and G-703. Review capitalized costs including change orders, indirect costs and out-of-pocket costs. Test for completeness by looking for any missing elements (e.g., land shaping costs may be in a separate contract). Review invoices for any pre-purchased installed equipment. On large construction projects, the taxpayer may separately pre-purchase items that have a long delivery time (e.g., large capacity electrical sub-stations or transformers). The examiner should verify if any pre-purchased electrical equipment is included in the total project cost. Reconcile Total Project Costs in the Taxpayer's Records with the Total Project Costs in the Study. Request a copy of the taxpayer's general ledger data to support the fixed asset amounts on the depreciation schedule. How does it compare it to the amounts shown in the study? Typically, the property unit numbers or reference numbers found in a study do not track the taxpayer's accounting entries. Find out what sources the preparer used in preparing his/her study. Verify that the total project cost in the study reconciles to the total cost basis of assets in the taxpayer's books and records. The revenue agent is in the best position to do this since he/she is the most familiar with the taxpayer’s accounting methods. The agent will also know where to look for other costs that should be in the building account, but may have been expensed or otherwise entered improperly into another account. Compare all data with the contemporaneous cost records. List any unsupported basis for potential disallowance. Reconcile Detailed Cost Breakdowns to individual property elements. Actual cost records should be used whenever possible. Review the taxpayer's internal "Job Cost Reports." Typically, a preparer relies on these documents to derive the unit costs (assuming that the cost and description of the assets in the Job Cost Reports are accurate). The study methodology should be disclosed in the Assumptions and Limiting Conditions section of the report. A careful analysis of the Job Cost Reports may yield significant audit adjustments because the taxpayer does not always properly classify items that are listed in this report. For example, the Job Cost Report includes a code for Furniture and Fixtures. Within this code are multiple records of vendors from whom the taxpayer claimed to have purchased items, such as furniture and fixtures. The preparer included the total cost as § 1245 property and listed it in the study as "FF&E." However, upon requesting contracts for each of the vendors under this heading, the Service examiner discovered that some of these assets were actually § 1250 property and, therefore, concluded that these costs were erroneously included in "FF&E." Therefore, it is important that the examiner review the vendor contracts in the Job Cost Reports, especially those that detail the "Description of Work", to verify asset costs. Prepare a List of Items/Costs that are Not Properly Substantiated. back to the top   Compute the Correct Costs (as necessary) for individual items or groups of property. Review the Cost Segregation Study/Report Again. Review the study for its style and order of presentation. The narrative typically describes the order of the development of costs and the spreadsheets show the analysis and sequence. Review the Study conclusions and recommendations. Review the Assumptions and Limiting Conditions. Verify that the assumptions and limiting conditions are consistent with the facts developed from the inspection and the review of drawings and specifications. Analyze How the Detailed Cost Breakdown was Prepared. Review Direct Costs. Typically, cost segregation studies will incorporate a mixture of §1245 and §1250 properties into unit-by-unit direct cost recommendations. A review of a study should include identification of any of these disputable costs, and ensure that §1245 properties are segregated from §1250 properties. Review Indirect Costs. Examiners need to ensure that any indirect costs are properly allocated to their respective assets. Indirect costs generally relate to the land, certain land improvements, and/or the building or other structures. Indirect costs generally do not relate to the placement of machinery or furniture and fixtures. However, there are exceptions, such as for the design of a manufacturing line. Refer to Chapter 4, "Principal Elements of a Quality Cost Segregation Study and Report," for additional discussion of indirect costs. Studies often use large spreadsheets and sophisticated formulas to compute the allocation of indirect costs (generally on a pro-rata basis). The examiner should verify any formula by testing the allocations of indirect costs to ensure they do not exceed the total indirect costs. Identify Potential Audit Issues. Site Preparation, General Grading and Land Shaping Costs Building and facility projects often require general grading, site preparation and other costs to make the site suitable for a proposed use. These costs, along with costs for stripping existing forest and vegetation, grading and compaction to provide a level site, and construction of site access roads, are generally non-depreciable costs allocable to the basis of land. A study may exclude these costs as being outside the scope of its work. In other instances, a study may argue that no costs are allocable to non-depreciable items. Whether these types of costs are included in the study or not, the examiner should determine all land shaping costs and allocate these costs to either non-depreciable land, to the building, and/or to land improvements. Before-and-after photographs may help with this determination. Also, the examiner should inspect the taxpayer's books and records to determine how these items were treated for financial and tax purposes. back to the top   Section 1245 Property – Did the Study Utilize Cost Estimates or Actual Cost Records? Review the § 1245 and § 1250 property listings and identify the most significant items. The examiner should check the contractor payment records (e.g., AIA Form G-702) to see if actual costs of these items were used in the study or whether these item costs were based on some sort of allocation or estimate. For example, if the Form G-702 shows $1.2 million for the "electrical" division work and the study shows or allocates $1.8 million to specialized § 1245 electrical equipment, then there may be a problem with the study’s cost determination. In this case, the examiner should request additional information to determine the source of the $1.8 million allocation. Note that this is only a "smell check," since additional equipment or other property purchased by the taxpayer outside the construction contract may significantly affect this type of comparison. Potential Problems with Residual Methods. When a residual approach has been used, the examiner must be especially careful when reviewing § 1245 property costs. In essence, this method estimates the § 1245 property costs and then simply assigns the remaining portion of the total cost to § 1250 property. In general, the § 1250 residual cost is neither estimated nor checked for reasonableness. All too often the result of this procedure is that the § 1245 property cost is too high and the § 1250 property cost is too low. Cost estimates can also be manipulated to produce unreasonably high estimates for § 1245 property. This is because there are a wide variety of cost data publications that may be used, and some of these have relatively high estimates for costs. Most data sources have a higher cost for installing only one unit (e.g., a single electrical outlet) as opposed to installing 10 or 100 units. "Quantity discounts" and competitive bidding may significantly reduce the actual unit cost. Accordingly, estimates for multiple units based on a single unit cost may be incorrect. The following is an example of this problem. Assume that 500 of the 120-volt electrical outlets in a particular building have been determined to qualify as § 1245 property. The R. S. Means DataBase, 2003 Edition, page 464, line 4015, lists a total price of $34.50 per 120-volt duplex receptacle. Based on this data, a study may estimate that the 500 outlets have a total installed cost of $17,250 (500 x $34.50). However, this estimate should be reviewed or compared with the contractor’s actual price in order to determine its validity. When the contractor was awarded the contract, he/she submitted a schedule of cost for each item of work, such as for plumbing, electrical, heating, and site work (Form G-702 and G-703). The examiner should review Forms G-702 and G-703 to determine the cost that the contractor assigned to the electrical work. If the Form G-703 indicates that $120,000 was assigned to electrical receptacles and there were 5530 receptacles to install, then the actual unit cost to install each receptacle is only $ 21.18 per outlet. The total actual cost for the 500 outlets is therefore only $10,590 (500 x $21.18). This compares to the estimated cost of $17,250 [Note that both cost estimates (based on either the R. S. Means data or on the contractor's actual costs) would need to be increased by any applicable indirect costs]. Potential Problems with "Rule of Thumb" Methods While the documentation of costs drawn from the use of a "rule of thumb" method is typically sketchy and inadequate, the examiner should not categorically reject a study involving the use of "rules of thumb." The documentation needs to be examined and verified on its own merits to determine if cost recovery properties are properly identified and placed into proper recovery periods. back to the top   B. Cost Analysis Of Existing Property For used or recently-acquired properties, the adjusted basis or purchase price is allocated between § 1245 and § 1250 property. However, different considerations and audit techniques will apply depending on the records available. In addition to the steps for new construction, the following audit steps for existing properties should be considered. Review the Acquisition Documents to determine the assets purchased. Determine whether there was a written purchase price allocation agreed to by the buyer and seller (you may need to contact the seller). If there was an allocation between personal and real property, then the allocation is binding on the taxpayer (and therefore a taxpayer’s subsequent cost segregation study is moot). Only the Service can challenge a contract allocation. See Section 1060(a); Commissioner v. Danielson, 378 F.2d 771 (3rd Cir. 1967), cert. denied, 389 U.S. 858 (1967); and North American Rayon Corp. v. Commissioner, 12 F.3d 583 (6th Cir. 1993). If there was not a written price allocation, then the examiner should address the study and go to the next step. Review the Escrow Documents and Payment Records to substantiate the overall purchase price. Ensure that the Land has been Properly Valued. Land included in the purchase price is valued first. The value of land should be determined at its "highest and best use." Properties tend to appreciate based on the value of land. Land value should not be reduced for any pre-existing environmental contamination because the prior owners are often held responsible for this and/or the property is generally insured for this situation. Ensure that Older Properties are Adjusted for Depreciation. Assets and asset groupings must be carefully reviewed and scrutinized to determine their physical and economic condition. Relatively new items should be valued as new (e.g., windows, building exterior, emergency generator). Older items may be physically deteriorated or functionally or economically obsolete and should be assigned a value commensurate with their condition or use. For example, a building may have been pre-wired for telephones but, if it is a "non-digital" system, it may have a low value. Ensure that Replacement Cost Values are Properly Adjusted for the actual condition and remaining economic useful life of the assets. The value of used components must be reduced from new replacement value in proportion to the observed economic obsolescence or physical depreciation as compared to similar new assets. This principle is discussed in regard to the Helipot Building in Lesser v. Commissioner, 42 T.C. 688 (1964), aff’d, 352 F.2d 789 (9th Cir. 1965), acq., 1966-2 C.B. 5, cert. denied, 384 U.S. 927 (1966). Review the Contract Files for information regarding the original construction and any subsequent repairs or modifications. This information should be used when viewing the existing condition of the building to verify, if possible, that the original contract work was performed. Review the Blueprints or Drawings. The existing structure should be compared to the "as-built" drawings to help identify subsequent repairs and modifications. Consider Demolition Expenses. Assets scheduled to be demolished should have no basis or value assigned to them. Code Section 280B provides that the demolition cost of any structure is a capital cost chargeable to the land. Any abandonment losses incurred in connection with a demolition should also be considered for capitalization to the land [See Priv. Ltr. Rul. 9131005 (Apr. 25, 1991)]. In summary, the examiner should ensure that: The study methodology considers the value of all the assets in place at the time of purchase or at the time the study is prepared, whichever is appropriate. The value of property items must take into account the physical wear and tear on each property item and any economic or functional