Cost Segregation Studies

When you buy, build or renovate a commercial building or rental property, the tax rules normally spread the cost over 39 years (or 27.5 years for residential rentals). But a building is not one asset. It contains carpeting, specialty electrical work, cabinetry, parking lots, landscaping and other items that can be depreciated much faster. A cost segregation study identifies those components so the faster schedules can be used. With 100 percent bonus depreciation restored for property acquired after January 19, 2025, the effect can be large.

The basic idea

Under the depreciation system (MACRS), recovery periods depend on what an asset is. Structural parts of a nonresidential building are 39-year property, and structural parts of residential rental property are 27.5-year property. Other items fall into shorter classes. An engineering-based study separates the purchase price or construction cost into these buckets.

Which items go in which category depends on facts and tax law, not just appearance. That is why the work is usually done by engineers or specialists, with a tax professional, and why results are documented in a written report.

Why bonus depreciation changes the math

Bonus depreciation generally applies to property with a recovery period of 20 years or less. Reclassified components in the 5-, 7- and 15-year classes therefore may qualify. For property acquired after January 19, 2025 and placed in service after that date, the allowance is 100 percent, and IRS Notice 2026-11 provides interim guidance. You can also elect out of bonus by class if you prefer to spread deductions.

Separately, a new category called qualified production property allows a 100 percent allowance for certain nonresidential real property used in manufacturing and similar production, if construction begins after January 19, 2025 and before 2029 and the property is placed in service after July 4, 2025 and before 2031. Property leased to others does not qualify, so this mainly affects owner-operators.

Properties and owners that may benefit

• Purchased, constructed or substantially renovated commercial property
• Hotels and motels, restaurants, retail centers, medical offices, car washes and self-storage
• Residential rentals, including short-term rentals, where the components can be identified
• Owner-occupied business property

Property bought in prior years may qualify through a catch-up. Filing Form 3115 for a change in depreciation method lets you claim depreciation that was missed, using the bonus percentage that applied when the property was placed in service. A negative section 481(a) adjustment, meaning an additional deduction, is generally taken entirely in the year of change. An automatic change is attached to a timely filed return, with a copy sent to the IRS.

Trade-offs to weigh

• Recapture on sale. Depreciation on shorter-life personal property is generally taxed as ordinary income when the property is sold at a gain, up to the depreciation claimed. Talk through your holding period before you accelerate deductions.
• Passive loss limits. If the deductions create a loss from a rental, the loss may be suspended unless you can use it against other income, for example as a real estate professional. See rental property taxes and our real estate tax services.
• Do you have income to use? A large first-year deduction is only helpful if there is income to offset now or a plan for a net operating loss.
• State taxes. Many states do not follow federal bonus depreciation.
• Exchanges. If you plan a like-kind exchange, coordinate before you reclassify.
• Cost and quality. Studies cost money and vary in quality. Benefit estimates based on rules of thumb can be misleading.
• Records. Keep the study, the allocation, and the asset schedule with your tax files.

How we can help

We help property owners estimate whether a study is worth pursuing, coordinate with engineers, apply the results through Form 4562 or Form 3115, and plan for passive loss rules, state differences and a future sale. See our real estate tax and tax planning services, or contact us.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.