Cost Segregation Overview & Calculator
Cost Segregation

Building Depreciation Reclassified

Cost segregation separates a building into components with different depreciation lives, shifting part of the cost into shorter recovery periods. This can increase deductions in earlier years and change the timing of tax benefits on income-producing real estate.

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Foundations

Overview of cost segregation and the mechanics behind separating building components.

Definition

What Is Cost Segregation?

Cost segregation is a method of separating the costs of a building into categories that qualify for shorter depreciation periods. Instead of depreciating the entire building over 27.5 or 39 years, certain components may be classified as 5-, 7-, or 15-year property.

Typical components identified include:

  • Land improvements such as parking areas, sidewalks, and site lighting
  • Specialized electrical and mechanical systems that primarily support equipment
  • Certain interior finishes and non-structural elements
  • Exterior features not integral to the building structure

Mechanics

How a Study Works

A cost segregation study typically combines engineering analysis with tax classification rules. The goal is to identify and measure components of a building that qualify for shorter recovery periods.

Core steps commonly include:

  • Reviewing construction plans, contracts, and cost records
  • Identifying and measuring eligible components within the building and site
  • Assigning depreciation lives based on applicable tax regulations and guidance
  • Calculating depreciation schedules across asset categories
  • Preparing a cost breakdown that summarizes the reclassified components
Where It Is Used

Types of buildings and projects where cost segregation is commonly applied.

Users

Who Typically Uses Cost Segregation?

Cost segregation can apply to a wide range of income-producing real estate. It is commonly used for both commercial and residential rental properties, as well as various specialized facilities. The method is not limited to any particular industry; many types of buildings may benefit depending on their design and use.

Examples include, but are not limited to:

  • Office buildings and professional spaces
  • Industrial, warehouse, and manufacturing facilities
  • Retail properties, shopping centers, and stand-alone stores
  • Hotels, hospitality venues, and lodging properties
  • Multifamily housing and residential rental properties
  • Medical offices, clinics, and healthcare facilities
  • Restaurants, entertainment venues, and specialty-use buildings
  • Automotive properties, dealerships, and service centers
  • Self-storage facilities and mixed-use developments

Property Characteristics

Property Types That May Qualify

Most income-producing real estate may be evaluated for cost segregation, including newly constructed buildings, recently acquired properties, and buildings placed in service in prior years where a detailed component breakdown has not been performed.

Common traits of properties considered for analysis include:

  • The property is depreciable real estate used in a trade, business, or for producing income
  • Total construction or acquisition costs are significant enough to benefit from detailed categorization
  • The building incorporates systems, finishes, or site work that fit shorter asset lives
  • There is a need to understand how much of the cost relates to shorter-lived components
Impact & Workflow

Potential outcomes from reclassification and a typical sequence for completing a study.

Impact

Common Results of Cost Segregation

  • Accelerated depreciation deductions in early years of ownership
  • Changes to the timing of tax deductions and reported taxable income
  • More detailed categorization of building components and site improvements
  • Potential alignment of depreciation patterns with renovation and replacement cycles

Sequence

Typical Study Process

Each project has its own details, but many cost segregation studies follow a similar outline:

  • Initial review of the property and high-level estimates of potential reclassification
  • Gathering construction documents, cost schedules, and related records
  • Reviewing plans, drawings, and building details
  • Engineering analysis to identify and measure eligible components
  • Assignment of recovery periods for each category of property
  • Development of updated depreciation schedules by asset class
  • Preparation of a summary that details the reclassified costs and categories