What Is a Cost Segregation Study?
A cost segregation study is an engineering-based analysis that identifies and reclassifies components of a depreciable building from IRC §1250IRC §1250 — Real PropertyGoverns depreciation recapture on real property. §1250 property includes structural components of buildings (walls, roofs, HVAC, plumbing) recovered over 27.5 years (residential) or 39 years (nonresidential) under MACRS. Gain on sale triggers "unrecaptured §1250 gain" taxed at a maximum 25% federal rate.Cornell LII → real property (27.5- or 39-year recovery) into IRC §1245IRC §1245 — Personal PropertyGoverns depreciation on personal property (equipment, machinery, fixtures). §1245 recapture on sale is taxed as ordinary income to the extent of prior depreciation taken. Cost segregation converts §1250 property into §1245 property, accelerating deductions but also converting future gain to ordinary income.Cornell LII → personal property (5- or 7-year) and §1250 land improvements (15-year). This reclassification is authorized by IRC §168IRC §168 — Accelerated Cost Recovery System (MACRS)Establishes the Modified Accelerated Cost Recovery System. §168(e) specifies asset classes. §168(k) provides the special first-year bonus depreciation allowance.Cornell LII →.
The One Big Beautiful Bill Act of 2025 (Pub. L. 119-21, enacted July 4, 2025) permanently restored 100% first-year bonus depreciation under IRC §168(k)IRC §168(k) — Bonus DepreciationProvides additional first-year depreciation for qualified property. OBBBA §70302 restored 100% bonus for property acquired and placed in service after January 19, 2025 — permanently, not subject to phase-down.Cornell LII → for qualified property acquired and placed in service after January 19, 2025. Reclassified 5-, 7-, and 15-year components resulting from a cost segregation study are eligible for 100% first-year bonus depreciation — making the accelerated deduction available immediately rather than spread across the recovery period.
The Core Mechanics
Under MACRS, a standard commercial building is depreciated over 39 years (nonresidential) or 27.5 years (residential rental) on a straight-line basis. A cost segregation study identifies building components that qualify as §168(e)(3)(B)IRC §168(e)(3)(B) — 5-Year PropertyLists specific asset classes qualifying as 5-year MACRS property, including certain personal property used in connection with research and experimentation. Cost segregation identifies components qualifying under these classes.Cornell LII → 5-year or 7-year §1245 personal property (fixtures, electrical for equipment, specialty plumbing, decorative items) or 15-year §1250 land improvements (parking lots, sidewalks, landscaping, fencing), allowing much faster recovery — and, for post-1/19/2025 placements, immediate 100% bonus depreciation of those shorter-lived components.
Who Benefits
A cost segregation study is most economically justified for taxpayers who:
- Own or are constructing commercial real property with a depreciable basis of $500,000 or more (study fees typically range $5,000–$30,000; cost-benefit breaks positive at sufficient basis)
- Can utilize the resulting deductions — either as a §469(c)(7)IRC §469(c)(7) — Real Estate Professional ExceptionRemoves the per-se passive characterization for rental activities when the taxpayer materially participates and performs more than 750 hours of real property trade or business services, constituting more than half of all personal services. Passive losses from those activities become deductible against active income.Cornell LII → real estate professional, a short-term rental operator with average rental period ≤7 days and material participation (removing the activity from per-se §469(c)(2) classification), or a taxpayer with passive income to absorb passive losses under §469(i)IRC §469(i) — $25,000 Active Participation AllowanceAllows up to $25,000 of passive rental activity losses against active income for taxpayers who actively participate in rental real estate and have AGI ≤$100,000 (phases out $100K–$150K).Cornell LII →
- Have significant tax liability in early years of ownership
- Are planning to hold the property long-term (§1245 recapture on sale must be factored into the analysis)
Reclassified §1245 personal property is subject to full ordinary income recapture upon sale of the property, to the extent of prior depreciation taken. IRC §1245IRC §1245 RecaptureAll depreciation previously deducted on §1245 property is recaptured as ordinary income on sale. This contrasts with §1250 "unrecaptured gain" which is taxed at a maximum 25% federal capital gains rate.Cornell LII → recapture contrasts with §1250 "unrecaptured gain" (maximum 25% federal rate). A §1031 like-kind exchange can defer recapture. Plan exit strategy before committing to an aggressive reclass study.
Legal Authority — IRC, Regulations & IRS ATG
The Statutory Framework
| Authority | Key Provision | Relevance to Cost Seg |
|---|---|---|
| IRC §168 | MACRS depreciation system | Establishes 5/7/15/27.5/39-year recovery periods; §168(e) asset classes |
| IRC §168(e)(3)(B) | 5-year property definition | Certain §1245 personal property components qualify here |
| IRC §168(e)(6) | Qualified Improvement Property (QIP) | 15-year recovery; §168(k) eligible after CARES Act technical correction |
| IRC §168(k) | Bonus depreciation / OBBBA §70302 | 100% first-year bonus on reclassified short-life components (post-1/19/2025) |
| IRC §1245 | Personal property depreciation & recapture | Reclassified components become §1245 property; ordinary income recapture on sale |
| IRC §1250 | Real property depreciation & recapture | Structural components remain §1250; unrecaptured gain at max 25% rate |
| IRC §481(a) | Accounting method change adjustment | Catch-up adjustment for prior-year properties; favorable adjustment in year of change |
| IRC §167(a) | General depreciation | Foundational authority for deducting exhaustion of property used in trade or business |
| IRC §163(j) | Business interest limitation | Impacts leveraged real estate; large accelerated deductions may interact with §163(j) |
| IRC §469 | Passive activity rules | Determines whether accelerated losses can offset active/passive income |
IRS Cost Segregation Audit Techniques Guide (ATG)
The IRS published its Cost Segregation Audit Techniques Guide (first released 2004, updated 2022) — the definitive operational framework for both practitioners preparing studies and IRS examiners auditing them. The ATG explicitly accepts engineering-based cost segregation as a valid methodology, directly citing as the legal foundation. A study that follows the ATG's methodology and documentation standards is positioned for examination.
The ATG is available on the IRS website at irs.gov/businesses/cost-segregation-audit-techniques-guide.
Rev. Proc. 2024-23 is the current IRS publication listing automatic consent method changes. Cost segregation reclassifications are covered under Designated Change Number (DCN) #7 (changes in depreciation for MACRS property not previously excluded from MACRS) or DCN #184 (depending on the specific change). These automatic procedures allow taxpayers to file Form 3115 with their tax return — no IRS pre-approval is required.
Rev. Proc. 2015-13 provides the general procedures for accounting method changes, including the rules for §481(a) adjustments (taxpayer-favorable adjustments recognized in full in the year of change; unfavorable adjustments spread over 4 years).
Treas. Reg. §1.168(i)-8 — Partial Asset Disposition
When a building owner replaces a component previously identified in a cost segregation study, Treas. Reg. §1.168(i)-8 and Treas. Reg. §1.263(a)-3 permit a partial asset disposition election: recognize a loss on the retired component's remaining tax basis while capitalizing the replacement. This preserves the economic benefit of the study even when components are replaced during the hold period.
Qualifying Properties by Asset Class
Any depreciable real property can be the subject of a cost segregation study. The modeled reclass percentages below are illustrative ranges based on industry benchmarks — actual allocations depend on the specific building, construction costs, and the qualifying engineer's findings. They are not predictions of outcome.
Asset Class Breakdown: What Gets Reclassified
| Recovery Class | IRC Authority | Typical Components | §168(k) Eligible? |
|---|---|---|---|
| 5-Year Personal Property | §168(e)(3)(B); §1245 | Specialty electrical outlets for equipment, certain fixtures, computer-related systems, process plumbing | Yes — 100% bonus (post-1/19/25) |
| 7-Year Personal Property | §168(e); §1245 | Office furniture, certain equipment, removable partitions | Yes — 100% bonus (post-1/19/25) |
| 15-Year Land Improvements | §168(e); §1250 | Parking lots, sidewalks, fences, landscaping, site lighting, retention ponds | Yes — 100% bonus (post-1/19/25) |
| 15-Year QIP | §168(e)(6); §1250 | Interior improvements to nonresidential buildings (post-placed-in-service) | Yes — 100% bonus (post-1/19/25) |
| 27.5-Year Structural | §168(e)(2)(A); §1250 | Residential rental building structure, foundation, roof | No |
| 39-Year Structural | §168(e)(2)(B); §1250 | Nonresidential building structure, walls, HVAC serving building, permanent plumbing | No |
State Conformity — Key Non-Conforming States
Cost segregation itself (the reclassification of components among MACRS classes) generally conforms to federal treatment in all states that follow federal MACRS. The significant state variation arises with bonus depreciation under §168(k), which is decoupled in the following states as of 2026:
California, New York, New Jersey, Massachusetts, Connecticut, Pennsylvania, Hawaii, Arkansas, and the District of Columbia do not conform to federal §168(k) bonus depreciation as of 2026. In these jurisdictions, the 100% federal bonus deduction must be added back to state taxable income, and the property is depreciated under state-modified schedules. The cost segregation reclassification (5/7/15-year class) still applies at the state level — but without the first-year bonus pickup. State tax advisors must be consulted for multi-state property owners.
Texas and Florida have no state income tax; federal treatment is immaterial for state purposes in these jurisdictions.
Reclassification Waterfall Calculator
Enter building details to see an illustrative reclassification waterfall using midpoint industry benchmark percentages. All outputs are modeled impact under stated assumptions — actual allocations require a qualified engineering study.
Reclass Waterfall — Inline SVG Chart
Modeled Hero Scenarios
| Property | Depreciable Basis | Illus. Reclass % | Modeled Short-Life Basis | First-Year Bonus Pickup (37% Rate) |
|---|---|---|---|---|
| Office Building | $2,000,000 | ~27.5% midpoint | ~$550,000 | ~$203,500 |
| Multifamily (5+ units) | $5,000,000 | ~25% midpoint | ~$1,250,000 | ~$462,500 |
| Industrial / Warehouse | $10,000,000 | ~37.5% midpoint | ~$3,750,000 | ~$1,387,500 |
| Self-Storage | $3,000,000 | ~47.5% midpoint | ~$1,425,000 | ~$527,250 |
| Hospitality / Hotel | $4,000,000 | ~30% midpoint | ~$1,200,000 | ~$444,000 |
ⓘ Modeled Impact under stated assumptions. Illustrative reclass percentages are midpoints of industry benchmark ranges for informational purposes only. Actual reclassification requires a qualified engineering study. Tax impact assumes 100% bonus depreciation (post-1/19/2025 OBBBA), 37% federal rate, no state taxes, full deductibility of passive losses (REPS or equivalent). Actual tax impact depends on individual facts, entity structure, and passive activity posture. Consult a CPA.
Implementation — The Study Process
Step 1: Determine Feasibility
Before commissioning a study, evaluate cost-benefit. Study fees typically range from $5,000 to $30,000+ depending on property size and complexity. The study is economically justified when the net present value of accelerated deductions substantially exceeds the study fee. As a general rule (not a guarantee), properties with depreciable basis above $500,000 are candidates; properties above $2,000,000 often justify more comprehensive studies. A qualified CPA can model the NPV of accelerated deductions against study cost before commitment.
Step 2: Engage a Qualified Cost Segregation Engineer
The IRS Cost Segregation ATG is explicit: a defensible study requires engineering expertise. Qualifications to look for:
- Licensed professional engineer (PE) or registered architect with cost segregation experience
- Members of the American Society of Cost Segregation Professionals (ASCSP) — the primary credentialing body for the field
- Experience with the specific property type (hospitality, industrial, multifamily) — each requires different component-level analysis
- Explicit use of the Whiteco 6-factor test for each reclassified component
- Full written report with component-level allocation schedules and documentation
The IRS ATG explicitly identifies "residual estimation" and "rule of thumb" studies as non-compliant. Percentages applied to total cost without component-level engineering analysis do not withstand examination. Inadequate component documentation results in reclassification of most components back to structural real property during IRS examination.
Step 3: Field Survey and Documentation
The engineer conducts a physical site inspection (or reviews as-built drawings and cost records for completed buildings) to identify and document each component. For each reclassified item, the study must document:
- Physical description and location within the building
- Allocated cost from construction records or cost estimation databases
- Applicable MACRS recovery class and basis for classification
- Whiteco 6-factor analysis for each §1245 personal property component
Step 4: Look-Back Studies for Prior-Year Properties
A powerful feature of cost segregation is the ability to perform a look-back study on a property already placed in service in a prior year — without amending prior tax returns. Instead, the taxpayer files Form 3115Form 3115 — Application for Change in Accounting MethodFiled to change the method of accounting for depreciation on previously placed-in-service property. Under automatic consent (Rev. Proc. 2024-23 DCN 7/184), no IRS pre-approval is needed. The §481(a) catch-up adjustment is included on the return for the year of change.IRS.gov → to change its accounting method for depreciation, triggering a §481(a)IRC §481(a) — Accounting Method Change AdjustmentRequires a "catch-up" adjustment when a taxpayer changes an accounting method. Taxpayer-favorable §481(a) adjustments (i.e., where the new method would have resulted in more depreciation in prior years) are recognized in full in the year of change — a single-year catch-up of all missed acceleration.Cornell LII → catch-up adjustment that captures all the additional depreciation that would have been deducted in prior years if the study had been done at acquisition — all recognized in the single year of change.
Scenario (illustrative): A taxpayer acquired a $3M industrial warehouse in 2022 and depreciated it as 39-year property. In 2026, the taxpayer commissions a cost segregation study identifying 37% of basis ($1.11M) as 5/7/15-year property.
Modeled §481(a) adjustment: The taxpayer would have deducted substantially more depreciation in 2022–2025 under the shorter recovery periods (including applicable bonus depreciation for 2022–2024 placed-in-service if pre-OBBBA). The cumulative difference — the amount of accelerated depreciation "missed" in prior years — is recognized as a negative §481(a) adjustment (favorable to the taxpayer) in 2026, the year of the Form 3115 filing.
Key point: No 2022, 2023, 2024, or 2025 amended returns are required. The catch-up deduction appears entirely on the 2026 return. All figures are modeled under stated assumptions; actual amounts require an engineering study and CPA computation.
Stacking Opportunities
Cost segregation pairs with several complementary strategies:
| Strategy | IRC Authority | Interaction with Cost Seg |
|---|---|---|
| §179D Energy-Efficient Commercial Buildings | IRC §179D | Deduction for energy-efficient commercial building property; can be claimed alongside accelerated depreciation on reclassified components |
| §45L New Energy-Efficient Home Credit | IRC §45L | Credit for multifamily builders; stacks with residential rental cost seg study |
| Partial Asset Disposition | Treas. Reg. §1.168(i)-8; §1.263(a)-3 | Recognize loss on replaced components identified in original study; avoids "double depreciation" |
| Real Estate Professional Status | IRC §469(c)(7) | Enables deduction of passive losses from accelerated depreciation against active income |
| §1031 Like-Kind Exchange | IRC §1031 | Defers §1245 recapture on sale; critical exit strategy consideration |
Forms & Elections
Form 3115 — Application for Change in Accounting Method
Form 3115 is the primary procedural vehicle for implementing a cost segregation study on property already placed in service. Under the automatic consent procedures of Rev. Proc. 2024-23 (the current IRS automatic method change publication), taxpayers do not need prior IRS approval to make this change.
Identify the Designated Change Number (DCN)
Cost segregation changes typically fall under DCN #7 (change in depreciation for MACRS property not excluded from MACRS — includes change from longer recovery period to correct shorter period) or DCN #184. The applicable DCN depends on the specific nature of the change. A CPA experienced in Form 3115 filings must determine the correct DCN for the taxpayer's facts.
Calculate the §481(a) Adjustment
The §481(a) adjustment is the difference between (a) the depreciation that would have been allowed under the new (correct) method and (b) the depreciation actually allowed under the old method, for all prior open years. A taxpayer-favorable §481(a) adjustment — where the new method would have produced more depreciation in prior years — is recognized in full in the year of change. An unfavorable adjustment is spread over 4 years.
Prepare and File Form 3115
The completed Form 3115 is attached to the taxpayer's timely filed federal income tax return for the year of change (including extensions). A copy must also be sent to the IRS National Office. The return must include the full §481(a) adjustment amount. Note: Form 3115 preparation for a complex cost segregation change typically requires a CPA or tax professional experienced in method changes.
Apply §168(k) Bonus to Reclassified Assets (New Acquisitions)
For property acquired and placed in service after January 19, 2025: the reclassified 5-, 7-, and 15-year components identified in the study are eligible for 100% first-year bonus depreciation under OBBBA §70302. This is elected (or opted out of) on Form 4562. Opt-out elections are available by property class under §168(k)(7).
File Form 4562 — Depreciation and Amortization
Form 4562 reports all depreciation and amortization for the year, including bonus depreciation claimed on reclassified components. The form includes separate lines for §179 elections and §168(k) bonus depreciation. A new Form 4562 must be filed each year depreciable assets are placed in service, or in any year a §179 deduction is claimed.
Election to Reduce Bonus Depreciation
Under §168(k)(7)IRC §168(k)(7) — Election Out of Bonus DepreciationAllows taxpayers to elect not to claim bonus depreciation for any class of qualified property placed in service during the year. The election is made for an entire class of property and cannot be made on a property-by-property basis.Cornell LII →, taxpayers may elect not to apply bonus depreciation to any class of qualified property placed in service during the year. The election is made by property class. No partial-percentage election is available for post-1/19/2025 property under OBBBA.
Key Rev. Procs. Referenced
| Publication | Subject | Relevance |
|---|---|---|
| Rev. Proc. 2024-23 | Automatic consent method changes (current) | Lists DCN #7 and #184 for cost seg changes; governs Form 3115 filing under automatic consent |
| Rev. Proc. 2015-13 | General method change procedures | Rules for §481(a) adjustments; 4-year spread for unfavorable adjustments; one-time filing rule |
§6662 — Accuracy-Related Penalty Posture
Substantial authority or adequate disclosure required under IRC §6662. The IRS may assert the §6662 accuracy-related penalty (20% of underpayment) if a position lacks substantial authority and is not adequately disclosed on Form 8275. Maintain documentation supporting the bona fide nature of the strategy.
Audit Defense
Cost segregation studies conducted by qualified engineers following the IRS ATG methodology are generally well-positioned for examination. The IRS itself published the ATG as the examination standard, meaning a study that adheres to it gives examiners their own playbook to evaluate — and the taxpayer the same document to defend with.
IRS ATG Examination Framework
When an IRS examiner encounters a cost segregation study, the ATG directs them to evaluate:
- Qualifications of the study preparer — engineering credentials, ASCSP membership, experience with the property type
- Methodology used — engineering-based component analysis vs. residual or rule-of-thumb approaches
- Quality of documentation — component-level schedules, cost allocations from construction records, photographs, field survey notes
- Whiteco factor analysis — was the 6-factor test applied to each reclassified §1245 component?
- Reasonableness of allocations — do the percentages make sense for the property type? (A 60% reclass on a simple office building would be unusual)
High-Risk Signals to Avoid
- Unusually high reclass percentages for the property type — e.g., 50%+ for an office building or standard multifamily
- Non-engineer preparers — CPAs or non-engineers signing studies without engineering input
- No field survey — studies prepared entirely from square footage estimates or cost databases without physical inspection
- Missing Whiteco analysis — study report does not apply the 6-factor test to individual components
- Identical percentage allocations across multiple properties — sign of a rule-of-thumb approach
- Study not integrated with Form 3115 filing — cost seg completed but method change never formally filed
- Double-counting QIP — treating the same interior improvements as both QIP and 5/7-year personal property
Burden of Proof
Under the foundational principle that the burden of proof rests on the taxpayer to substantiate the proper classification of each reclassified component. General assertions of component movability or separability, without component-level documentation, are insufficient. The study report itself is the primary substantiation document and must be retained for the entire applicable statute of limitations period (generally 3 years from filing, but 6 years if substantial omission is alleged).
Responding to IRS Examination
If an examiner challenges a cost segregation study:
- Produce the full engineering study report with component schedules
- Demonstrate the preparer's engineering credentials and ASCSP certification where applicable
- Cite the controlling legal authority
- Walk the examiner through the Whiteco 6-factor analysis for challenged components
- Reference the IRS's own ATG as the applicable examination standard
- Engage a CPA or tax attorney experienced in cost segregation examination defense to manage correspondence
Because the IRS published the ATG as its own examination guide, a taxpayer whose study fully adheres to ATG standards can walk an examiner through the guide chapter by chapter. The ATG explicitly endorses the engineering-based, component-by-component methodology. A study that deviates from ATG standards, however, creates examination risk that cannot be remedied after the fact.
Frequently Asked Questions
A cost segregation study is generally economically justified when: (1) the depreciable basis of the property is $500,000 or more; (2) the taxpayer has sufficient tax liability in the early years of ownership to utilize the accelerated deductions; and (3) the net present value of accelerated deductions exceeds the study fee. For a look-back study on a property already in service, the §481(a) catch-up adjustment (recognized entirely in the year of the Form 3115 filing) can justify the study even years after acquisition. A qualified CPA should model the NPV of the deductions against study cost before committing.
No. A look-back study on a property already placed in service does not require amended returns. Instead, the taxpayer files Form 3115 with its current-year tax return, making an automatic accounting method change under Rev. Proc. 2024-23. The §481(a) adjustment captures all the cumulative additional depreciation from prior years in a single catch-up deduction on the current-year return. This is one of the most compelling features of the cost segregation strategy.
Upon sale of the property, §1245 recapture applies to all previously deducted depreciation on reclassified personal property components — this recapture is taxed at ordinary income rates (up to 37% for individuals). This contrasts with §1250 "unrecaptured gain" on real property, which is subject to a maximum federal capital gains rate of 25%. The economic benefit of the cost segregation study is the time value of money — deductions taken today (at ordinary income rates) are worth more than deductions deferred to future years, even accounting for recapture. A §1031 like-kind exchange can defer both §1245 recapture and §1250 unrecaptured gain. Plan exit strategy with a CPA before implementing.
Under OBBBA §70302 (Pub. L. 119-21, enacted July 4, 2025), 100% first-year bonus depreciation is permanently restored for qualified property acquired and placed in service after January 19, 2025. For a cost segregation study on a post-1/19/2025 acquisition, the reclassified 5-, 7-, and 15-year components are eligible for 100% first-year bonus depreciation — meaning the entire reclassified short-life basis can potentially be deducted in year one. The 39-year structural portion is not eligible for bonus depreciation and continues on straight-line MACRS. Taxpayers may elect out of bonus depreciation by class under §168(k)(7).
Passive investors face limitations under IRC §469. The cost segregation deductions will generally be passive losses that can only offset passive income (not active wages, business income, or portfolio income). However, there are important exceptions: (1) §469(c)(7) real estate professional — a taxpayer who performs more than 750 hours of real property business services and that constitutes more than half of all personal services removes the activity from per-se passive status, allowing passive losses to offset active income; (2) Short-term rentals with material participation — where the average rental period is 7 days or less and the taxpayer materially participates, the activity is not a per-se passive rental and losses may offset active income; (3) §469(i) $25,000 allowance — taxpayers who actively participate in rental real estate can deduct up to $25,000 of passive rental losses against active income (phases out $100K–$150K AGI). For passive investors without these exceptions, accelerated deductions build up as suspended passive losses that are released upon taxable disposition of the property.
Qualified Improvement Property (QIP) under IRC §168(e)(6) is any improvement to the interior of a nonresidential building placed in service after the building was first placed in service, excluding structural components, elevators, escalators, and internal structural framework. After the CARES Act technical correction (2020), QIP has a 15-year MACRS recovery period and qualifies for §168(k) bonus depreciation — meaning 100% first-year deduction for post-1/19/2025 QIP. QIP is a subset of §1250 real property (not §1245 personal property), so it is subject to §1250 unrecaptured gain (25% cap) rather than §1245 full ordinary recapture. Cost segregation and QIP are complementary: a tenant improvement project may include both QIP components and §1245 personal property components, each requiring separate classification.
The fee paid for the cost segregation study is generally deductible as a business expense under IRC §162 in the year paid (for cash-basis taxpayers) — it is not capitalized as part of the building's depreciable basis. This is an additional economic benefit: the study fee generates an immediate current deduction, while the accelerated depreciation from the study's findings generates additional multi-year deductions. Total cost of the study should be weighed against the NPV of the resulting accelerated deductions to confirm economic viability. Consult a CPA regarding the specific deductibility treatment for your entity type.
Yes, cost segregation studies can be performed on residential rental property (single-family rentals, duplexes, and small multifamily under 5 units). These properties have a 27.5-year recovery period rather than 39 years, but reclassifiable components (appliances, carpeting, site improvements, landscaping) still qualify for 5-, 7-, or 15-year treatment. The net acceleration benefit is smaller than for nonresidential commercial buildings due to the shorter baseline recovery period, and study fees may not be economically justified for single-property SFR investments. The strategy is more compelling for larger multifamily portfolios. Documentation standards for residential rental cost segregation must be especially rigorous, as most apartment components are structural by nature.
IRC §179D is the energy-efficient commercial buildings deduction — a separate provision that provides a per-square-foot deduction for energy-efficient improvements to commercial buildings meeting specific energy performance standards (ASHRAE 90.1). It is not cost segregation. The two can be claimed simultaneously on the same property: §179D applies to the energy-efficient building systems (HVAC, lighting, building envelope), while cost segregation reclassifies components across the broader building. The interaction requires coordination because §179D may reduce the depreciable basis of the system receiving the deduction, affecting subsequent depreciation. A CPA and energy engineer should coordinate both analyses.
Under Treas. Reg. §1.168(i)-8 and Treas. Reg. §1.263(a)-3, when a taxpayer disposes of a component of a building (e.g., replaces the HVAC system, roof, or flooring), the taxpayer may elect to recognize a loss on the retired component's remaining adjusted tax basis rather than continuing to depreciate "ghost assets." This election is particularly valuable when a cost segregation study has identified specific components at specific costs: upon replacement, the taxpayer can recognize the tax loss on the old component's remaining basis, avoiding "double depreciation" (depreciating both the old component and the new replacement simultaneously).