What Is a Cost Segregation Study?

When you buy a building for one price, you receive many assets with different tax lives. The IRS Cost Segregation Audit Techniques Guide, Publication 5653, explains that property is typically separated into individual items or groups having the same recovery periods and placed-in-service dates. When only lump-sum costs are available, cost estimating techniques may be required to segregate or allocate costs to items such as land, land improvements, buildings, equipment, furniture and fixtures. That analysis is generally called a cost segregation study.

The guide states the motive plainly: the underlying incentive is the significant tax benefit from shorter recovery periods and accelerated depreciation methods. It describes a building as section 1250 property, generally nonresidential real property with a 39-year recovery period, and describes equipment, furniture and fixtures as section 1245 tangible personal property with shorter recovery periods, such as 5 or 7 years.

One caution on the source. The guide is written to help IRS examiners review studies, and it says it is not an official pronouncement and may not be cited as authority. The version we read is marked February 2025, and it states it is current through its revision date. It is still the clearest public account of how the IRS looks at these studies, but your CPA should rely on the law itself.

Some items are easy. The guide's own example notes that a turnkey project includes tangible personal property, such as phone and computer systems, process piping and storage tanks. Others are less clear. It says a study might report parts of the building, such as carpeting, wall coverings, partitions, millwork and lighting fixtures, as section 1245 property, and that these items may or may not qualify depending on the particular facts and circumstances.

Building systems are harder still. The guide gives the example of electrical systems that support both equipment and the building, with a study allocating part of the electrical distribution system to equipment such as specialized kitchen equipment. It then says that allocating building components to section 1245 property is often a contentious issue. It also describes complex and often conflicting guidance and a lack of bright-line tests.

This has a practical implication for owner-users. Clinical, laboratory, food and light manufacturing buildings may have more specialized systems to review than a plain office, but whether those systems qualify turns on facts, not on the type of building. Do not assume a percentage from a marketing brochure. The guide does not give one, and we do not either.

A study changes when you recover the cost of a building more than how much you recover. Faster deductions now can be followed by lower deductions later, and by tax on sale.

Interest in these studies rises and falls with the bonus depreciation rules, so check the date of anything you read. IRS Publication 946, for use in preparing 2025 returns, says that unless you elect out, you must take a 100% special depreciation allowance for certain qualified property acquired and placed in service after January 19, 2025. Qualified property includes tangible property depreciated under MACRS with a recovery period of 20 years or less, and it can be new or certain used property. For the first tax year ending after January 19, 2025, you can elect a 40% allowance instead.

An IRS news release dated January 14, 2026 describes Notice 2026-11 as guidance on the permanent 100% additional first year depreciation deduction for eligible depreciable property acquired after January 19, 2025. Publication 946 also states that property acquired before January 20, 2025 follows the earlier phase-down rules. The acquisition date can therefore change the result, so give your CPA the contract date as well as the closing date.

Note that the audit guide, dated February 2025, describes the bonus rules as they stood before this change, so use Publication 946 and your CPA for the current percentages. Rules can change again. State income tax treatment can also differ, and that is a question for your CPA.

The guide says there are currently no standards for preparing these studies, and that they vary widely. It adds that there are no prescribed qualifications for preparers, but that credentials and expertise may bear on accuracy and quality. In general, it says, a study by a construction engineer is more reliable than one by someone with no engineering or construction background, though experience in cost estimating and knowledge of tax law are also important.

It defines a quality study as accurate and well-documented, and lists thirteen principal elements. Use the ones below to review a proposal.

• ✓Does the proposal identify the preparer, with credentials, experience and expertise?
• ✓Will the study describe its methodology and the steps used to classify assets and determine costs?
• ✓Which approach will be used? The guide names detailed engineering, survey or letter, residual estimation, sampling or modeling, and rule of thumb approaches. Ask why this one was chosen.
• ✓What documents will it use, and will there be a site visit?
• ✓Will it explain the legal analysis behind classifying assets as section 1245 or section 1250 property?
• ✓Will it show unit costs and an engineering take-off?
• ✓Will total allocated costs reconcile to total actual costs?
• ✓How will it treat indirect costs and land?
• ✓Does it consider related issues, such as any change in accounting method?

The reconciliation point deserves special attention for a buyer. Your cost is what you paid, including items your CPA adds to basis. A study should tie back to that figure.

A study costs money, and its benefit depends on your tax position. Tenant Advisory Group is a broker, not a tax advisor. We can give your CPA the purchase documents and your use plans so the question gets looked at early. These steps help you decide.

1. Ask your CPA whether the company, or its owners, can use larger deductions now. A deduction you cannot use now is worth less to you, and the passive activity rules may limit it if the building sits in a separate company.
2. Ask for a simple comparison: 39-year depreciation alone against an estimate with a study, using your own tax rate and expected holding period.
3. Get a fee quote and a sample report from at least one provider with engineering and tax experience.
4. Consider the exit. Ask what happens on a sale, including depreciation recapture, under IRS Publication 544's rules, and how a future 1031 exchange would fit.
5. If you are planning a build-out, ask whether to run the study after construction, so all costs can be included and classified together.
6. If you already own a building, ask whether a study for prior years would be handled through an accounting method change, which the guide treats as a related issue.

Timing also matters for the land split. A study explains how land and land development costs are treated, and those costs are generally not depreciable. Keep the appraisal, survey and closing statement together, since each may be needed.