Electrical Distribution Systems: The Most Disputed Component in Cost Segregation Audits

I recently spent 90 minutes interviewing James C. Peacock — former IRS General Engineer and Subject Matter Expert who spent 38.5 years at the IRS examining cost segregation studies, contributed to every version of the Cost Segregation Audit Techniques Guide from its 2004 release through the February 2025 update, and personally trained roughly 200 new-hire IRS engineers before retiring in September 2025.

One topic came up repeatedly: electrical distribution systems. According to James, EDS is the single most contested line item in cost segregation audits. The 2025 ATG made it official by dedicating a full chapter — Chapter 8 — to EDS classification methodology. Here is what he told me.

Why Electrical Gets Disputed More Than Anything Else

Every building has electrical wiring. That wiring serves two distinct functions. Some of it powers the building — lighting, HVAC, elevators, general outlets. That is Section 1250 property, depreciated over 39 years (or 27.5 for residential). Some of it powers equipment that happens to be installed in the building — industrial machinery, restaurant cooking equipment, data center servers, commercial laundry. That equipment is personal property under Section 1245, eligible for 5-year or 7-year accelerated depreciation.

The electrical infrastructure connecting to that equipment — the dedicated panel, the conduit, the wiring — can follow the equipment into 1245 classification. But only if the taxpayer can prove the electrical system is truly dedicated to that equipment and not doing double duty as general building service.

The dollar amounts are significant. In a restaurant, a commercial kitchen might pull 200 amps of dedicated service. In a manufacturing facility or data center, purpose-built electrical infrastructure can represent hundreds of thousands of dollars. The difference between classifying that infrastructure as 5-year personal property versus 39-year structural building component is dramatic — and the IRS knows it.

What Scott Paper Established — and What It Did Not

The controlling case is Scott Paper Co. v. Commissioner. James walked me through what it actually held.

"Scott Paper established that if you have a dedicated panel — a panel that serves one specific piece of equipment, like an electric dryer or an electric stove — and only that equipment, then that panel can be allocated to the 1245 property. That is the rule. The word 'dedicated' is doing all the work."

— James C. Peacock, former IRS Engineer SME

The key word is "exclusively." The panel must serve that specific equipment and nothing else. A circuit that runs to a piece of manufacturing equipment but also feeds a few overhead lights along the way does not qualify. A subpanel that handles both commercial cooking equipment and general kitchen lighting does not qualify. Only when the panel is truly and solely dedicated to the personal property does the electrical infrastructure follow it into 1245 treatment.

Scott Paper is covered in ATG Chapter 8, and it is the methodology IRS engineers are trained to apply. If your cost segregation study allocates EDS differently — or worse, does not reference this standard at all — expect scrutiny.

The Right Method: Demand Load Analysis

The IRS-approved method for allocating electrical costs in a cost segregation study is a demand load analysis. This is an engineering calculation. An engineer reviews the electrical drawings, identifies each panel and subpanel, calculates the connected load for each circuit, and assigns those loads to either personal property or building service based on what the circuit actually serves.

This is not the same as an energy usage study. James was direct about the difference:

"An energy usage study measures how much electricity a piece of equipment actually consumed over a period of time. That is not what we are looking for. A demand load analysis is based on the installed capacity — the rated load of the equipment connected to each circuit. Those are two completely different calculations. Using the wrong one is a documentation problem."

— James C. Peacock, former IRS Engineer SME

The demand load analysis must be property-specific. It must trace back to the electrical drawings for that building. If the study uses a generic percentage — "we allocate 30% of electrical costs to personal property for restaurant properties" — that is a square footage model dressed up as engineering. James told me that approach tells IRS engineers the provider "used averages and didn't look at the property," and it generates more Information Document Requests (IDRs) immediately.

The demand load analysis needs to identify specific panels and specific circuits. It needs RS Means cost codes — not just "RS Means electrical" with no code. If the IRS engineer flips to the back of the report and finds vague codes or no codes at all, that is an IDR trigger. See what an IRS engineer looks for in a cost seg study for a full breakdown of what examiners check in the first pass.

Where This Matters Most: Restaurants, Data Centers, Manufacturers

The dedicated-use EDS rule has the most financial impact in three property types.

Restaurants

Commercial kitchens run on heavy dedicated electrical service. A panel serving only the hood system, the commercial range, or the walk-in cooler compressor can follow that equipment into 5-year personal property. But the kitchen also has general lighting, standard outlets, and ventilation. A sloppy study that allocates all kitchen electrical to 1245 — without tracing each circuit — will not survive an audit. The correctly documented study traces each subpanel and circuit back to the equipment it serves.

Data Centers and Manufacturing

These are the highest-stakes EDS cases. Purpose-built facilities often have transformer vaults, dedicated distribution boards, and conduit runs that exist solely to serve the computing or production equipment. The dollar amounts on these electrical allocations can reach into the millions. The demand load analysis needs to be thorough and property-specific. IRS engineers on large cases have seen adjustment factors where 1245 estimates were multiplied 10x to match the actual purchase price — which James described as a major red flag signaling something is missing in the underlying estimate.

Multi-Family and Self-Storage

These property types come up less often in EDS disputes, but they are not immune. In self-storage, metal partitions screwed into walls can qualify as 1245 property if the owner proves they are actually removed and relocated. The same movability logic applies to electrical. Common-area power pedestals and tenant-space panels in self-storage with dedicated circuits to individual units can qualify — but only with documentation proving dedicated use.

The LUQ Problem: When EDS Percentages Draw IRS Scrutiny

The IRS uses a framework called LUQ — Large, Unusual, Questionable items. Any line item in a cost segregation study that looks out of proportion to what is typical for a property type will be flagged for additional review. James gave me a straightforward example:

"If you have a standard warehouse — not refrigerated, no special equipment — and the study claims 50% of the electrical costs are personal property, that is a Large Unusual Questionable item. That is going to get scrutiny. The IRS never published percentage thresholds, and that was deliberate. As soon as we say X percent is acceptable, everyone's going to claim X minus 1 percent."

— James C. Peacock, former IRS Engineer SME

Because there are no published safe-harbor thresholds, the only defense is documentation. A demand load analysis that traces the 50% allocation back to specific dedicated circuits serving specific identified equipment is defensible. The same 50% without that underlying engineering is not — regardless of how the report is written.

This is the broader principle James called "the support, not the report." An IRS engineer reviewing your cost segregation study is not reading the prose summary. They are looking at what evidence supports the numbers. A persuasively written report with vague documentation is a worse outcome in an audit than a plainly written report backed by property-specific engineering calculations.

What the IRS Engineer Actually Asks For

When a cost segregation study gets examined — and this only happens inside an already-open audit, not as a standalone trigger; see the full audit risk breakdown here — the IRS engineer will issue an Information Document Request. For EDS specifically, the first IDR typically asks for:

• 1 The original electrical plans and specifications from construction
• 2 The contractor's final application for payment (the actual invoice itemizing electrical work)
• 3 The demand load analysis worksheet from the cost seg engineer
• 4 Panel schedules showing which circuits serve which equipment
• 5 Property-specific RS Means cost codes used in the estimate (12 or 16-digit codes, not category headings)

If the initial IDR response is vague or incomplete, the IRS issues more IDRs. "The least amount of IDRs, the easier the audit goes," James told me. Every round of back-and-forth is an opportunity for the IRS engineer to find additional issues. Answering the first IDR completely and specifically — with actual panel schedules and demand load calculations, not a narrative explanation — is the goal.

For more on the full IDR process and what IRS engineers review from the first page of a cost seg study, read what IRS engineers actually look for in a cost seg audit.

The AI-Generated Study Problem

AI-generated cost segregation studies are appearing in the market. James was direct about where they fail:

A study produced without a physical site inspection cannot produce a valid demand load analysis. The engineer needs to see which panels exist, trace which circuits serve which equipment, and verify what the electrical drawings show versus what was actually built. That requires being at the property. No AI tool running off uploaded documents can substitute for that inspection when the IRS examiner asks for a property-specific electrical engineering calculation.

Where James sees AI potentially adding value: as a completeness check on the 1250 side. "We would get cost seg studies where there was so much emphasis on getting the 1245 property estimated that the 1250 property was an afterthought," he said. A study missing significant structural components draws its own scrutiny, because IRS engineers check whether the totals add up to the purchase price — missing land or missing 1250 items are automatic flags. AI tools that flag completeness gaps are useful. AI tools that replace the site inspection and demand load analysis are not.

How to Protect Your EDS Allocation

The defense for an EDS allocation comes down to four things:

The same principle applies to other disputed property types. Kitchen cabinets and counters have their own documentation requirements — the 2012 Amerisouth ruling established they are generally 27.5-year property unless removal and reuse is documented. See what Amerisouth v. Commissioner means for kitchen component classifications and the broader court case landscape.

James's core principle — "it's the support, not the report" — applies directly here. A well-documented demand load analysis tied to specific circuits and specific equipment is the entire defense. The narrative explanation of your methodology is irrelevant if the underlying engineering calculation is not there.

Questions to Ask Your Cost Seg Provider About EDS

If you are evaluating a cost segregation study for a restaurant, manufacturing facility, data center, or any property with significant process equipment, ask these questions before engaging a provider:

• Q: Do you perform a demand load analysis or an energy usage study for EDS allocations? (Correct answer: demand load analysis.)
• Q: Will the report include property-specific RS Means cost codes at the 12 or 16-digit level?
• Q: How do you document dedicated use for each circuit included in the 1245 allocation?
• Q: Will you perform a physical site inspection, or is this study based on documents only?

A provider who cannot answer these questions specifically — or who gives you a percentage-based EDS allocation without referencing dedicated use or a demand load analysis — is producing a study that will not hold up. For a full checklist on evaluating cost seg study quality, see what cost segregation is and how a defensible study is built.