Cost Segregation
Cost segregation is an engineering-based tax study that reclassifies portions of a building's depreciable basis from 27.5- or 39-year schedules into shorter 5-, 7-, and 15-year recovery periods to accelerate depreciation deductions.
What it means
A cost segregation study identifies and quantifies specific building components that qualify for shorter IRS recovery periods — flooring, landscaping, site improvements, specialty electrical, millwork, and similar items. The engineer-prepared study reclassifies these items out of the 27.5-year (residential) or 39-year (commercial) building schedule into 5-, 7-, or 15-year schedules.
The tax benefit is accelerated depreciation: larger deductions in early years when the time value of money is highest. Cost seg pairs powerfully with bonus depreciation — the reclassified components qualify for bonus, which can dramatically front-load deductions. Studies typically cost $5K–$25K and make economic sense on properties with improvement basis above $500K–$1M.
Example
A $2M commercial property with $1.6M depreciable basis. Straight-line 39-year yields ~$41K annual depreciation. Cost seg reclassifies 25% ($400K) into shorter schedules, producing meaningfully higher first-year deduction when combined with bonus depreciation.
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