Cost Segregation Studies: How to Accelerate Real Estate Depreciation and Save Taxes

Cost segregation is the single most impactful tax strategy for real estate owners, yet many building owners have never heard of it. Under IRC 168, the entire cost of a commercial building is typically depreciated over 39 years (nonresidential) or 27.5 years (residential rental), producing a relatively small annual deduction. A cost segregation study breaks the building into its component parts and identifies assets that qualify for shorter recovery periods: personal property (5-7 years), land improvements (15 years), and qualified improvement property (15 years). With 100% bonus depreciation restored by the OBBBA for property acquired after January 19, 2025 (no scheduled end date), all of these shorter-lived components can be deducted in full in the year the property is placed in service. The IRS endorsed the use of cost segregation studies in its Audit Technique Guide for Cost Segregation (2004), providing detailed guidance on how these studies should be performed and what qualifies for reclassification. The key is that the study must be performed by a qualified professional (typically an engineer working with a CPA) who examines the building’s construction documents, inspects the property, and applies engineering principles to determine the proper classification of each component.

How does a cost segregation study work?

Do components of a building you buy used qualify for bonus?

Yes, as long as you didn’t use the property before you bought it and you bought it from an unrelated party. Bonus covers new property and certain used property. The prior-use test looks back over the five calendar years before the year you place it in service, plus the part of that year before the placed-in-service date, and having had a depreciable interest in it counts as use.

Section 179 has the same purchase rule, so related-party, gift, inheritance and carryover-basis acquisitions don’t qualify for it either. One thing to watch on a purchased building is qualified improvement property. QIP means an interior improvement you make to nonresidential property after the building was first placed in service. The interior that came with a building you bought isn’t QIP just because it’s inside, but a build-out you add later can be.

Can you spread a cost seg write-off over several years?

Yes, by electing out of bonus, but the election works by class. If you elect out for 5-year property, every 5-year asset you placed in service that year goes on regular MACRS, and you can revoke the election only with IRS consent. It’s made on a timely return, or on an amended return within six months of the original due date.

On regular MACRS, 5- and 7-year components use 200% declining balance and 15-year land improvements use 150%, generally with the half-year convention. Mid-quarter applies instead if more than 40% of the year’s depreciable basis, not counting real property, went into service in the last three months. Section 179 is more flexible where it applies, since you can expense part of an item’s cost, but on a building it only reaches the section 1245 components plus, by election, QIP, roofs, HVAC, fire protection and alarm systems, and security systems.

When does a cost segregation study pay for itself?

A cost segregation study typically pays for itself when the building’s purchase price or construction cost exceeds $1 million, though properties with heavy tenant improvements or specialized systems can benefit at lower values. The study reclassifies building components from 39-year (commercial) or 27.5-year (residential) property into 5, 7, or 15-year categories, accelerating depreciation deductions. Common reclassified items include carpeting and floor coverings (5-year), decorative lighting and millwork (7-year), site improvements like parking lots and landscaping (15-year), and specialized electrical and plumbing serving specific equipment. The tax savings from a cost segregation study depend on the bonus depreciation percentage in effect, your marginal tax rate, and the percentage of building costs that can be reclassified, which typically ranges from 15% to 40% of total building cost.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.