A cost segregation study is an engineering analysis that reclassifies components of a real estate purchase or construction from 39-year commercial real property (or 27.5-year residential) into shorter-lived personal property and land improvements depreciable over 5, 7, or 15 years. Combined with bonus depreciation, this strategy can generate very large first-year deductions that would otherwise be spread over decades. On a $2 million commercial building, a cost segregation study might identify $400,000-$600,000 of accelerated components - producing $400,000+ of additional first-year depreciation.
5-year property: Carpeting, certain fixtures, removable partitions, specialized equipment attached to the building for the owner-operator's specific use (not the building's general operation).
7-year property: Office furniture and fixtures embedded in the construction, certain equipment.
15-year property (land improvements): Parking lots, sidewalks, landscaping, fencing, exterior lighting. These qualify for bonus depreciation unlike the 39-year building shell.
What stays at 39/27.5 years: The structural components - foundation, roof, walls, HVAC serving the building generally, plumbing, electrical for general building use. These are §1250 property and do not qualify for reclassification.
A cost segregation study on a $3 million office building purchased in 2026 might reclassify $600,000 of components to 5 and 15-year property. With OBBBA restoring 100% bonus depreciation permanently for qualified property acquired and placed in service after January 19, 2025 (IRC §168(k) as amended by OBBBA §70301), the entire $600,000 of reclassified short-life components can be expensed in year one. At a 37% marginal rate, that produces roughly $222,000 of tax savings in year one versus roughly $5,700/year if those components depreciated over 39 years. The time value of accelerating $222,000 of tax over a typical hold period is substantial.
A cost segregation study can be performed on property already placed in service in prior years - a "look-back" or catch-up study. The taxpayer does not need to amend prior returns. Instead, a Form 3115 (Change in Accounting Method) is filed in the current year to take the entire cumulative missed depreciation as a §481(a) adjustment in one year. This is one of the most powerful retroactive tax strategies available for real estate owners who have been depreciating property over 39 years without a prior cost segregation analysis.
When cost-segregated property is sold, the previously accelerated depreciation is subject to recapture. Personal property (5/7-year) is recaptured as ordinary income under §1245. Land improvements (15-year §1250 property) are subject to unrecaptured §1250 gain at up to 25% for individuals. The building shell portion is §1250 unrecaptured gain. Understanding the recapture profile is essential before executing a cost segregation strategy on property likely to be sold within a few years - the benefits may be partially eroded at exit.