Why cost segregation

Why cost segregation

Cost segregation splits a building's purchase price into the parts the tax law lets you depreciate quickly and the part it does not. Without a study, the whole cost of a rental building, less land, runs over 27.5 years for residential rental or 39 for nonresidential. A study identifies the components that qualify for 5-, 7- or 15-year recovery under MACRS and documents the cost assigned to each.

IRC §1245 covers tangible personal property; IRC §1250 covers the building and the structural components listed in Treas. Reg. §1.48-1(e)(2) — walls, floors, ceilings, windows, doors, HVAC, plumbing, general wiring and lighting, stairs, elevators, sprinklers.

Recovery periods come from Rev. Proc. 87-56: class 00.3 land improvements at 15 years (paving, fencing, landscaping, drainage, exterior lighting), class 57.0 at 5 years for most personal property in a rental, and 7 years where no class life applies.

Two decisions carry the borderline calls. Hospital Corporation of America, 109 T.C. 21 (1997), brought the investment-credit tests across to depreciation, which is why wiring dedicated to equipment can be §1245 property. Whiteco Industries, 65 T.C. 664 (1975), supplies six factors of permanence: whether the item can be and has been moved, whether it was designed to stay, how long it is expected to remain, how hard it is to remove, what damage removal causes, and how it is attached.

What 100% bonus depreciation changes

The 2025 budget reconciliation law made 100% bonus depreciation permanent for qualifying property acquired after January 19, 2025. The 5-, 7- and 15-year classes qualify; the building does not. Earlier acquisitions stay on the phase-down schedule, and the acquisition date follows the written binding contract rules of IRC §168(k), not the closing date alone.

Component typeWithout a studyWith a study
Building and structural components27.5 or 39 yearsNo change
Land improvements (class 00.3)Bundled with the building15 years, bonus-eligible
Tangible personal property (§1245)Bundled with the building5 years, or 7 with no class life; bonus-eligible
LandNot depreciableNot depreciable
The bonus rate turns on the acquisition date — the written binding contract date where there is one, else the closing — and the placed-in-service date. The 5-, 7- and 15-year classes qualify; the building does not. Federal treatment only.

An illustrative example

Round numbers for illustration; this is not a client result. A rental house bought for $1,000,000 with $200,000 in land leaves $800,000 of depreciable basis and a first full year near $29,000. A study finding $160,000 of 5-year property and $40,000 of 15-year land improvements takes the first year to roughly $221,800 — about $192,700 more, worth around $71,000 at a 37% marginal rate.

The benefit is timing. Later deductions are smaller, on sale the acceleration is subject to recapture under §1245 and §1250, and whether the loss offsets other income this year turns on the passive activity rules of IRC §469, which you apply.

Annual deduction by year: straight-line over 27.5 years against the accelerated schedule. Year 1 with SegFlow includes 100% bonus on the 5- and 15-year classes, so later years are smaller than without.

Estimated federal tax saving from the sample study by marginal rate. Year 1: additional deduction $110,852; at 24% $26,605, 32% $35,473, 37% $41,015. Year 2: additional deduction −$4,074; at 24% −$978, 32% −$1,304, 37% −$1,507. Year 5: additional deduction −$4,074; at 24% −$978, 32% −$1,304, 37% −$1,507. Cumulative, years 1–5: additional deduction $94,556; at 24% $22,693, 32% $30,258, 37% $34,986.

PeriodAdditional deductionAt 24%At 32%At 37%
Year 1$110,852$26,605$35,473$41,015
Year 2−$4,074−$978−$1,304−$1,507
Year 5−$4,074−$978−$1,304−$1,507
Cumulative, years 1–5$94,556$22,693$30,258$34,986
Additional deduction from the sample study (with the study less without) and the estimated federal saving at three marginal rates. Years after the first are smaller with the study, because the accelerated classes were deducted in year 1; the cumulative line is the net over 5 years. Illustration only: each marginal rate is applied to the sample study's federal depreciation deductions. Actual savings depend on the taxpayer's complete return, including passive-activity limits, state conformity and recapture on disposition, and are for the preparer's evaluation only.

Short-term rentals and look-back studies

A short-term rental averaging seven nights or less is generally nonresidential: 39 years on the building, 5-year treatment on the furnishings. Furnished, it carries more reclassifiable basis than a long-term rental at the same price.

A property placed in service earlier needs no amended returns: you file Form 3115 and take the depreciation not previously claimed as a §481(a) adjustment in the year of change.

Where SegFlow fits

You upload the documents and images you already have; SegFlow returns a PDF study, a Word version and an Excel ledger in under an hour, for your review and signature; see pricing. It carries no engineer's signature and is not an engineered site-visit study. For large or specialized commercial property, write to admin@segflowai.com; we answer within one business day.


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