IRS Views and Rules on Cost Segregation
Cost segregation is not only a favorite of taxpayers and professionals across the country but has been officially recognized by the IRS as the most accurate way to calculate depreciation outside of more common techniques. While cost segregation has a long history as an entity between loophole and law, it has now become the primary way for commercial properties to use accelerated depreciation.
The court case of HCA vs. IRS put the argument to bed permanently in 2001. In 2001, The IRS released the Information from the Cost Segregation Audit Techniques Guide in response to the case. This 100-page document saw the IRS codify into tax law what had been in practice for decades. Cost segregation would then get a bigger boost with the Tax Cuts and Jobs Act (TCJA) of 2017, which slashed taxes, improved cost segregation, and added the factor of bonus depreciation. With cost segregation now a matter of law, the IRS has embraced the concept, though with strict rules.
Quoting the IRS
“…to calculate depreciation for Federal income tax purposes, taxpayers must use the correct method and proper recovery period for each asset…”
– The Cost Segregation Audit Techniques Guide
the IRS is referring to is a cost segregation study when it mentions “determining the proper recovery period.” A cost segregation study is designed to find all depreciable assets, while classifying them by lifespans of five, seven, or 15 years. These short-life assets are the primary targets of a cost segregation study. Real estate, on the other hand, has a lifespan of 30 years for apartments and 40 years for commercial properties.
The Tax Cuts and Jobs Act of 2017
The biggest boost that cost segregation ever got came in 2017 with the Tax Cuts and Jobs Act (TCJA). This introduced bonus depreciation, which allowed taxpayers to depreciate all assets with a lifespan of five, seven, and 15 in one year. This produced massive savings that could even reach up to 50% of the total cost of a piece of real estate.
To illustrate how the Job Act influences cost segregation and depreciation, let us look at an example. This is for a standard office building with a depreciation basis of $4 million, purchased in 2019.
The One Big Beautiful Bill and Reinstatement of Bonus Depreciation While the Tax Cuts and Jobs Act of 2017 was originally scheduled to sunset, starting December 31, 2022, On July 4, 2025, The One Big Beautiful Bill was signed into law permanently reinstating 100% bonus depreciation. Qualifying assets put into service after January 19, 2025 can now be written off immediately, which keeps cost segregation a valuable strategy for maximizing deductions.
Updated Bonus Depreciation Timeline
- Sept. 28, 2017 – Dec. 31, 2022 100% bonus depreciation available under the Tax Cuts and Jobs Act (TCJA).
- 2023 80% bonus depreciation (first step in the scheduled phase-down).
- 2024 60% bonus depreciation.
- Jan. 1 – Jan. 19, 2025 40% bonus depreciation (final phase of the TCJA phase-down).
- Jan. 20, 2025 and onward 100% bonus depreciation permanently restored
Without Cost Segregation (Straight-Line)
| Commercial Office Building | ||
|---|---|---|
| Depreciation | Potential Tax Savings at 37.0% | |
| First Year | $29,915 | $11,069 |
| Five Years | $440,171 | $162,863 |
With Cost Segregation (Straight-Line)
| Commercial Office Building | ||||
|---|---|---|---|---|
| Additional Depreciation | Potential Tax Savings at 37.0% | After Tax Fee | Return on Investment | |
| First Year | $135,884 | $50,277 | $3,150 | 16.0 to 1 |
| Five Years | $640,854 | $237,116 | $3,150 | 75.3 to 1 |
With Cost Segregation (including TCJA)
| Commercial Office Building | ||||
|---|---|---|---|---|
| Additional Depreciation | Potential Tax Savings at 37.0% | After Tax Fee | Return on Investment | |
| First Year | $1,187,055 | $439,210 | $3,150 | 139.4 to 1 |
It should be noted that the Jobs Act of 2017 is in a currently diminished state that is sunsetting out, to be phased out completely in 2027. However, there is evidence that the current administration is going to extend bonus depreciation in the future.
