What is cost segregation?

Sugam Sharma

Cost segregation is a tax strategy that accelerates depreciation by reclassifying parts of a purchased, constructed, or renovated building into shorter-life assets. The result: larger early-year deductions and improved cash flow—when used thoughtfully within your broader plan.

 

Plain-English definition

Cost segregation identifies building components—such as specialized electrical, dedicated HVAC, finishes, cabinetry, and site work—that qualify for 5-, 7-, or 15-year lives instead of the standard 27.5 or 39 years. Reclassifying these costs increases current-year depreciation and can pair with bonus rules when applicable.

 

When it’s worth exploring

• Newly acquired or newly constructed commercial property
• Residential rental property with significant basis
• Major renovations and build-outs
• Owners with current or near-term taxable income (where deductions matter)

How a study works (step-by-step)

1. Feasibility review — We gauge potential benefits based on property type, basis, and hold horizon.
2. Engineer-led analysis — An engineer and tax professional identify and quantify shorter-life components.
3. Report & schedules — You receive asset detail, class lives, methods, and defensible documentation.
4. Implementation — Your CPA books the reclass entries; if retroactive, a Form 3115 with a §481(a) adjustment may allow a single “catch-up” without amending prior returns.

Benefits

• Larger depreciation in earlier years (cash-flow relief)
• Better alignment of tax deductions with how the property is used
• Useful pre- or post-renovation to time deductions around cash needs

Cautions

• Possible depreciation recapture on sale; model your hold period
• Coordinate with current bonus rules and interest-limitation considerations
• Ensure the study is defensible (engineer involvement is best practice)

Mini-case example

A $3.5M office purchase is placed in service. A study moves $600K into 5-/7-/15-year classes. First-year depreciation increases dramatically, freeing cash for tenant improvements and reserves—without changing operations.

 

FAQs

Do I need an engineer?

For credibility and exam support, yes—engineer involvement is strongly recommended.Can I do this on an older building? Often yes, via Form 3115 catch-up.Does bonus depreciation apply? Potentially—depends on asset class and year.

Want to see if your property qualifies?

We’ll run an initial ROI screen and map next steps.