US Federal Cost Segregation

Scope

Applies to US taxpayers (sole props, LLCs, partnerships, S/C corps, investors) owning real property in a trade, business, or rental — new construction, acquisitions, or already-in-service look-back studies. Tax year 2025, incl. the Jan. 19/20, 2025 OBBBA bonus depreciation cutoff. Use when determining reclassifiable basis, bonus rate, Form 3115 look-back need, or passive-loss usability. Does NOT cover personal residences, dealer property, foreign property, or §1031 mechanics itself.

Rules

• Straight-line depreciation recovery periods — 27.5 years residential, 39 years nonresidential years (§168(c))
• Cost segregation reclassification — A cost segregation study reclassifies components into §1245 personal property and land improvements on 5-, 7-, or 15-year MACRS schedules, accelerating (not increasing) total depreciation, typically 20%–40% of basis depending on property type. (§168(c))
• Whiteco nine-factor classification test — Classification follows the Whiteco nine-factor test — movability, permanence, affixation, and whether a component serves the building generally or a specific business process. (Whiteco, 65 T.C. 664 (1975))
• Documentation standard — Should be documented per the IRS Cost Segregation Audit Techniques Guide's "detailed engineering from actual cost records" standard (methodology narrative, traceable cost detail, photographs, preparer qualifications), since a flat rule-of-thumb percentage with no engineering support is the most common audit target. (IRS Cost Segregation Audit Techniques Guide)
• Land value allocation — Land value must be allocated separately and is never depreciable.

Self-checks

The cost segregation report itself includes a methodology narrative and traceable cost detail — not just a summary allocation schedule. Land value has been allocated separately and is excluded from every depreciation class. §1245 recapture exposure on eventual sale (or inside a contemplated §1031 exchange) has been modeled, not just the year-one deduction.

Sources

IRC §168 (MACRS, incl. §168(c) recovery periods, §168(k) bonus depreciation) IRC §179 (expensing election) IRC §469 (passive activity losses — §469(c)(2), §469(c)(7), §469(i)) IRC §481(a) (accounting method change adjustment) IRC §1(h)(6) (unrecaptured §1250 gain rate) IRC §1245 / §1250 (recapture) IRC §167(a); Treas. Reg. §1.167(a)-5 (land/building allocation)

Contributed by James Wallach.