Home / Tax Credits / Cost Segregation

IRC Section 168, Form 3115 method change · Form 3115 · Depreciation strategy, not a credit

Cost Segregation

If you own the building, an engineering study can pull years of depreciation into this year

This is a timing strategy, not a credit. Read the recapture section before you commit.

Why businesses miss this one

Owners assume it only works in the year they buy. It does not. A building you bought years ago can still be studied, and the entire cumulative catch-up is deductible in one year through an accounting method change, with no amended returns required.

How the money actually works

• A cost segregation study does not create a single additional dollar of lifetime deduction. It moves deductions earlier. The benefit is the present value of that timing shift.
• An engineering study reclassifies parts of a building's cost out of 39-year or 27.5-year depreciation into 5-year, 7-year, and 15-year classes.
• Because everything in those shorter classes has a recovery period of 20 years or less, it is eligible for 100% bonus depreciation under current law.
• Typical 5-year items: carpet, decorative lighting, dedicated electrical, appliances, signage. 7-year: furniture and specialized equipment. 15-year land improvements: paving, sidewalks, landscaping, fencing, site utilities.
• Look-back studies are the highest-leverage use. You cannot amend prior returns for this, but you can file Form 3115 to change your accounting method and take the entire cumulative missed depreciation as a single deduction in the current year.
• That catch-up is a favorable adjustment, which means it is deductible in full in the year of change rather than spread out. A building placed in service in 2019 can deliver several years of missed depreciation on this year's return.
• The method change is automatic, carries no user fee, and has no statute-of-limitations restriction on how far back the study looks.

What to gather before you call anyone

Organized records are the difference between a preparer who says it is not worth the trouble and one who finds the money. Have these ready.

• Purchase closing statement and the allocation between land and improvements
• Construction documents, blueprints, and actual cost records where available
• A site visit and photographs by the study preparer
• An engineering take-off with unit costs, reconciled to total actual cost
• Form 3115 attached to a timely filed return, with a duplicate copy sent to the IRS Ogden office
• A written study documenting methodology, legal analysis, and the specific property classified

Disqualifiers and traps

These are the places claims fall apart, either at filing or on examination.

• Recapture on sale is real. The reclassified personal property is recaptured as ordinary income at rates up to 37%, versus a 25% maximum on the depreciation you would otherwise recapture on the building. On that slice the arbitrage runs against you. If you plan to sell within three to five years, run the exit math before you commit.
• Passive activity rules can make the deduction worthless in year one. For an individual investor who is not a real estate professional, the resulting loss is generally suspended until there is passive income or a full disposition.
• If you bought the property as part of a business purchase and signed a purchase price allocation agreement with the seller, you may be bound by those allocations. The Tax Court denied a study on exactly these facts in Peco Foods. Negotiate the allocation schedule before closing, not after.
• The IRS has published no standards for study preparation and no qualifications for preparers. The entire substantiation burden sits with you, so preparer quality is the whole ballgame.
• Rule-of-thumb studies that apply an industry-average percentage with no site visit and no take-off are specifically called out by IRS examiners as unreliable.
• Percentage-of-savings fee arrangements are an explicit examiner flag. The IRS audit guide instructs examiners to determine the nature of the fee arrangement.
• A preparer who mischaracterizes 39-year property as 5-year property can be personally penalized. That has already happened.
• Land is never depreciable, and allocating too little to land is where studies most often fail on audit.

One more thing worth knowing

The current IRS audit guide was published in February 2025, before the July 2025 tax law changes. Its bonus depreciation and Section 179 chapters are out of date even though the methodology chapters are not.

Sources

Every figure on this page traces to one of these. All verified August 14, 2026.

• IRS Publication 5653, Cost Segregation Audit Technique Guide
• Revenue Procedure 2025-23, List of Automatic Changes
• Instructions for Form 3115
• IRS Publication 544 (2025), Sales and Other Dispositions of Assets

Other programs

• FICA Tip CreditAvailable now
• Research and Development Tax CreditAvailable now
• Section 179 and Bonus DepreciationAvailable now
• Qualified Production PropertyDeadline ahead
• Commercial Solar Investment CreditDeadline ahead
• Work Opportunity Tax CreditNot available

This is educational information, not tax advice. Big Brain Funding is not a CPA firm, an enrolled agent, or a tax preparer. We do not prepare, file, or sign tax returns, and we do not determine whether any business is eligible for any tax program. Eligibility depends on facts specific to your business and on tax law that changes. Nothing here is a promise of a refund, a credit, or a deduction amount. Confirm everything with a licensed CPA or enrolled agent before you file or amend a return.

Program details on this page were verified against official IRS and government sources on August 14, 2026. Tax law changes, sometimes mid-year. Check the linked sources for the current position before acting.