Under IRS cost segregation guidelines, a significant portion of a building’s cost can be depreciated over a shorter period of time.
If you own the building that houses your operations—and you’re currently planning (or recently completed) the construction or renovation of that building—then listen up. You should consider cost segregation as a tax planning tool. It allows you to accelerate depreciation deductions on your real estate assets. (It applies if you’re in the purchasing stage, too.)
Generally, nonresidential buildings are depreciated using a 39-year depreciation period.
But, under IRS cost segregation guidelines, a significant portion of a building’s cost can be depreciated over a shorter period of time. Certain building components may qualify for a reduced recovery period over five or seven years. Qualified improvement property (QIP) and exterior land improvement may qualify for a reduced recovery period over 15 years.
What Are ‘Building Components’?
Examples of building components that may qualify for a reduced recovery period over five or seven years include:
- Appliances and machinery (including machinery foundations) not related to the operation and maintenance of the building
- Electrical wiring and plumbing allocatable to machinery and equipment that is not unrelated to the operation and maintenance of the building
- Furniture and counters
- Lighting
- Removable carpet and wall tile
- Removable partitions
- Security and fire protection
What Are ‘Exterior Land Improvements’?
Examples of exterior land improvements that may qualify for a reduced recovery period over 15 years include items like:
- Curbs
- Fences
- Landscaping
- Lighting
- Parking lots
- Playgrounds
- Sidewalks
- Signs
- Swimming pools
- Tennis courts
- Utilities
What Is ‘Qualified Improvement Property’?
Qualified improvement property placed in service after 2017 must include both of these requirements:
- Property must be an improvement to the interior portion of a building that is nonresidential real property
- Improvements must be placed in service after the date the building was first placed in service by any taxpayer
A qualified improvement property placed into service has a 15-year recovery period.
When Cost Segregation Makes Sense
Will cost segregation be a good fit for you? Here are some scenarios where it may make sense:
- Business taxpayers that acquire nonresidential real property or residential rental property can accelerate depreciation deductions through a cost segregation study and realize accelerated (and often immediate) tax savings to improve cashflow.
- Businesses that acquire nonresidential real property or residential rental property have an opportunity to reduce the depreciable lives on assets that are considered building components. Certain assets may qualify for shorter lives and recovery periods under MACRS (IRS tax code) depreciation. Reduction of asset lives can accelerate deductions to offset taxable income.
What Are the Tax Benefits?
To determine potential tax benefits, conduct a cost segregation study. This helps identify and reclassify assets so you can take advantage of tax benefits like bonus depreciation.
Ideally, a cost segregation study is conducted prior to the time a building is placed into service (i.e., when it’s under construction or being purchased). If a building is being purchased, the sales price can be allocated between real and personal property in the sales contract.
Alternatively, a cost segregation study can be completed after a building is placed in service.
There are significant tax benefits associated with cost segregation.
- Section 179 immediate expensing and bonus depreciation (60% in 2025) may apply to the five-, seven-, and 15-year property reclassifications noted above. This can create significant and immediate cash savings for the taxpayer.
- State and local real property tax reduction. Cost segregation may result in the reduction of state and local real property taxes by reducing building costs allocable to real property. In addition, nearly half of all states provide sales and use tax exemptions for tangible personal property used in a manufacturing process or for research and development. A cost segregation study can identify this qualifying personal property, but tax savings depend upon the classification of the property as real or personal based on applicable state laws.
- Energy-efficient commercial building property deduction. Cost segregation studies may help identify prior and current expenditures related to heating and cooling, ventilation, hot water, interior lighting, and the building envelope that qualify for energy tax deductions. The deduction amount depends on the tax when the property is placed into service.
By maximizing depreciation deductions, you can reduce taxable income and improve cash flow. To learn more about this option, contact the experts at Bronswick Benjamin, an NSCA Member Advisory Councilmember.
