The concept of cost segregation is almost as old as the income tax itself. As the original income tax was formulated to go after the wealthy, a litany of accountants, tax experts, attorneys, and lobbyists have been looking for ways to get relief. Cost segregation began to truly manifest in the 1960s, as business owners and real estate investors looked to counter the outdated depreciation schedule of 39 years for commercial properties. The argument was put forward that the disparate parts of a commercial property would depreciate long before the whole property would.

First using tax reforms in the 1960s and then in the 1980s to expand the reach of depreciation, cost segregation became a key component in reducing the tax burden for the owners of large real estate portfolios. In those days, cost segregation was kind of a cheat code for those with the wealth and expertise to exploit it. This helped contribute to the building booms of the period, especially in high-tax areas such as New York City.

Cost segregation existed as a glorified loophole for decades, until the Supreme Court case of HCA vs. IRS in 1997. This ruling set cost segregation into legal stone, forcing the IRS to go from fighting the practice to codifying it. This led directly to the Cost Segregation Audit Techniques Guide, a source released by the IRS that acts as the formal guide on how cost segregation is to be carried out. It is this format that O’Connor and other property tax professionals still use to this day. It is through this rubric that cost segregation must be carried out, and our experts know it like the back of their hands.

The most important event to happen to cost segregation since the 1997 case was the Tax Cuts and Jobs Act (TCJA) of 2017. This introduced the concept of bonus depreciation, which was a giant step forward. Bonus depreciation not only introduced grand savings for taxpayers but also extended cost segregation to older buildings that were purchased by the owner, not just new construction as had been previously ruled. This opened the floodgates for taxpayers to see income reductions like never before.

While bonus depreciation has been in a sunset period, further legislation could reset this period or remove it entirely. There was legislation proposed in 2024 that would bring bonus depreciation back to 100%, and the new administration is very amenable to the possibility of expanding both cost segregation and bonus depreciation. This makes 2025 and beyond a banner time to explore how this technique can benefit your business and wallet.