Cost Segregation Study

Detailed Explanation

A cost segregation study is an engineering-based analysis that breaks a real estate property's purchase price into individual components, then reclassifies each component into the shortest applicable MACRS recovery period. The default treatment lumps everything (other than land) into the 27.5-year (residential rental) or 39-year (commercial) building shell, depreciating evenly. A cost seg study commonly identifies 20% to 35% of total basis as 5-year property (carpet, decorative lighting, accent finishes), 7-year property (some equipment), 15-year property (parking lots, sidewalks, landscaping, fences), or qualified improvement property. The reclassified components are then depreciated under MACRS rules and qualify for Section 168(k) bonus depreciation. OBBBA permanently restored 100% bonus depreciation for qualifying property placed in service after January 19, 2025, dramatically increasing first-year deductions. Combined effect: a $1,000,000 residential rental with $200,000 reclassified to 5-year/15-year property and 100% bonus could generate $200,000+ of first-year deductions on top of the regular building depreciation. Studies are most valuable for properties over ~$500K; engineering-based studies cost $3,000 to $15,000 depending on size and complexity. Look-back studies (Form 3115 change of accounting method) catch up missed depreciation on properties placed in service in prior years without amending. Caveat: components reclassified to 5/7/15-year property are Section 1245 property, recaptured at ordinary rates on sale (vs Section 1250 for the building, taxed at max 25% unrecaptured gain). Most investors plan to hold long-term, 1031 exchange, or pass at death (Section 1014 step-up basis) to defer or eliminate the recapture.