Illustrative Cost Estimation and Reconciliation
The arithmetic a quality study must show: component costs add to depreciable basis, and estimates are scaled if the first pass misses the total — with the audit guide’s limits on step-up factors. Educational information, not tax advice.
Educational information, not tax advice.
Updated 2026-10-14
Assumptions
- Educational information, not tax advice.
- Assume an acquisition study whose first takeoff, priced from a cost manual, does not match purchase price less land.
- Land is out of the total before reconciling depreciable amounts. Do not scale land.
- The ATG treats a uniform pro-rata step-up factor as not an acceptable method. Any scaling that is used must be disclosed and must not replace quantities.
- Any dollar figures below are invented for arithmetic only. They are not a typical mix and not a client result.
Key takeaways
- Reconciliation is not optional. The audit guide treats it as an element of a quality study.
- Scaling a takeoff to actual basis is a disclosed method with limits. A silent uniform step-up is the method the ATG rejects.
- Land must be out of the total before reconciling depreciable amounts. Do not scale a vendor invoice that already is actual cost.
- The same estimating technique should be used for all components. Mixing a detailed short-life takeoff with a residual building can skew toward §1245.
An acquisition study’s first takeoff, priced from a cost manual, comes in above or below the purchase price less land. The study scales every depreciable line by the same factor so the schedule ties to basis, and it writes that factor down — or, better, it revises quantities, location factors, and condition until the gap is explained. Suppose, for arithmetic only, purchase price $5 million, land $1 million, first takeoff of depreciable items $4.4 million. Those invented figures exist to show a gap. They are not a warehouse result. The ATG itself uses a warehouse step-up example as a method to reject.
The audit guide treats reconciliation as an element of a quality study. A schedule that does not add up cannot be tested. Educational information, not tax advice.
Order of operations for the arithmetic: substantiate contract price and capitalized costs; remove land at a supportable value; list actual invoices (FF&E, equipment) so they are not estimated twice; take off remaining quantities; apply a cited unit-cost source consistently; allocate indirects on a stated method; compare to depreciable basis; explain or disclose any remaining difference; do not plug the gap with a rule-of-thumb personal-property percentage.
What not to scale
Do not scale land. Do not scale a vendor invoice that already is actual cost just to make a pretty total if that invoice is already in the basis. If the seller’s bill of sale already priced the racks at an invented $200,000, that invoice is the cost of the racks. Inflating it by the same factor used on estimated drywall is double-counting and misstatement.
Do not scale only the short-life lines. Residual estimation — costing personal property in detail and dumping the remainder into the building — is the ATG’s less accurate path and generally does not reconcile. Mixing techniques can skew results toward §1245.
The rejected step-up
Chapter 3 of Publication 5653 states that applying a pro-rata step-up factor to estimates to force reconciliation to purchase price is not an acceptable method, and it illustrates the point with a warehouse. Replacement cost new less depreciation should approximate purchase price less land fair market value because of physical deterioration and functional obsolescence on used property — not because a multiplier was applied in the dark.
If this illustration discloses a factor at all, it is after quantities are fixed and as a transparent bridge, with the gap explained. A quality report’s exhibits include cost-source reconciliation. Hide the factor, and an examiner cannot test the study.
Indirects and §263A
Design fees, permits, contractor overhead, and capitalized interest, if they are in basis, have to ride along. The ATG lists explanation of the treatment of indirect costs as a quality element, and consideration of §263A as a related aspect. This page does not compute uniform capitalization. It says: pick a method, apply it to all classes, and write it down.
The guide’s outlet example notes that any estimate, from a published database or actual contractor cost, would need to be increased by applicable indirect costs. Forgetting indirects on building lines while loading them onto personal property is another way to skew.
Cost sources and consistency
Cite volume, page, and item. Use the same manual vintage and location factor throughout. The ATG names R. S. Means and Marshall Valuation Service as examples of reliable published sources; it does not endorse a vendor and it shows that database figures can diverge from actual contractor unit cost. CostSeg SI does not claim an operational RSMeans agent or an accuracy figure (F-18).
Boddie-Noell is the case-level caution against unsupported percentages. If quantities cannot be observed, stop. Do not invent a schedule to fill a proposal.
What reconciliation enables downstream
A schedule that ties to basis is what the CPA can enter on Form 4562. A look-back’s §481(a) adjustment is only as good as the historical basis that was reconciled. A Peco Foods writing, if one exists, is an upstream limit: you cannot reconcile to a split that contradicts a binding §1060 allocation.
QA should fail a draft that does not add up. That failure is a successful review, not a delay to paper over. Educational information, not tax advice.
Sources
- 1IRS Publication 5653 — Cost Segregation Audit Techniques Guide (rev. 2-2025)(opens in a new tab)
Written for IRS examiners. The guide states it is not an official pronouncement of law and cannot be cited as authority. It predates the July 2025 law.
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