Cost Segregation
What Is Cost Segregation?
Cost segregation is an IRS-approved tax strategy that allows property owners to accelerate depreciation by identifying and reclassifying certain building components into shorter recovery periods.
Rather than depreciating an entire structure over 27.5 or 39 years, cost segregation separates qualifying components into 5‑, 7‑, or 15‑year assets, increasing depreciation deductions in earlier years.
This strategy is explicitly recognized by the IRS and, when executed properly, has been upheld in multiple court cases.
Who Qualifies for Cost Segregation?
Any for-profit owner of real estate can potentially benefit from a Cost Segregation study:
- Businesses – businesses that own of commercial real estate, such as office buildings, manufacturing facilities, warehouses, healthcare facilities, self-storage, and other building types.
- Real Estate Investors – investors in commercial and residential real estate, including apartment buildings and short-term rental can significantly enhance their cash flow that can be reinvested into additional properties.
- High-Income Individuals – individuals in higher tax brackets who own real estate can benefit significantly from accelerated depreciation to reduce W-2 income.
Eligibility depends on property use, tax position, and timing, not just property type.
How Cost Segregation Works
Not all cost segregation studies are equal. A compliant cost segregation study uses engineering‑based analysis to:
- Identify building components
- Allocate costs based on construction details
- Classify assets under proper depreciation schedules
- Support findings with documentation and verification
Engineering‑based studies apply IRS‑recognized methodologies to generate tax savings that are defensible in audits. The result is accelerated depreciation, allowing taxpayers to improve cash flow while remaining compliant with tax law.
Non‑engineering or estimator‑only approaches increase audit risk and may result in disallowed depreciation.
Timing and Bonus Depreciation
Bonus depreciation provides a significant incremental benefit for property owners taking advantage of Cost Segregation. Bonus depreciation allows a percentage of the value of reclassified assets to be completely depreciated in the first year the property was placed in service. Under prior law, bonus depreciation percentages phase down according to the year the property was placed in service.
However, the One Big Beautiful Bill Act (OBBBA), enacted in July 2025, restored 100% bonus depreciation for qualifying property acquired after January 19, 2025, allowing qualifying property to be fully expensed in the year placed in service. This creates a renewed window for taxpayers to maximize upfront deductions through cost segregation, particularly for newly acquired, constructed, or recently improved properties.
2023
80%
2024
60%
2025 (Pre-OBBBA)
40%
2025+
100%
Despite the current return to 100% expensing, bonus depreciation remains subject to legislative limits and potential sunset provisions. As with prior phase‑downs, the availability and percentage of bonus depreciation may change in future tax years depending on Congressional action.
Audit Defense
Hull & Knarr has decades of experience defending Cost Segregation studies in front of the IRS and state taxing authorities. Because of our due diligence and expertise with the tax code, regulations, and case law, we use a reliable and strategic approach to defending the deductions under audit.
Documentation the IRS Expects
The IRS does not require perfection, but it does require credible methodology and consistent support for how assets are identified, classified, and valued. Strong cost segregation documentation typically includes:
- Engineering‑based narratives explaining how building components were identified and reclassified
- Detailed asset listings tied to specific components
- Drawings, invoices, and cost detail supporting allocations
- On‑site inspection notes and photographic evidence (where applicable)
- Logical and supportable cost estimation methodologies for assets without direct cost records
Cost segregation studies that rely primarily on broad estimates, rule‑of‑thumb allocations, or unsupported assumptions are significantly more likely to face IRS challenge and disallowance.
Audit Risk and Defensibility
The IRS uses its own degreed engineers to select and audit Cost segregation studies due to:
- Aggressive reclassification percentages relative to overall building value
- Studies performed retroactively without supporting construction detail
- Generic reports lacking asset‑level specificity
- Inconsistent methodologies across properties or tax years
An engineering‑based study, supported by detailed asset identification, construction documentation, and defensible allocation methodology, significantly reduces audit exposure and improves the sustainability of accelerated depreciation positions.
And if your study is audit, Hull & Knarr will be there to defend you in front of the IRS.
Hull & Knarr Experience
Hull & Knarr uses engineering‑based methodologies supported by CPA review, designed to maximize defensibility, not just the deduction size. We document your study as if it will be reviewed. And if you are audited, we will be there to defend you.
01
FEASIBILITY
Estimate of potential benefits for specific buildings. Our team identifies the property owner’s tax position and significant property characteristics to estimate study benefits.
02
GATHER
Next, our team collects documents like appraisals, property condition reports, ALTA surveys, closing purchase documents, blueprints, vendor reports, and/or construction documents.
03
ANALYSIS
After the standard data collection, we we conduct an on-site tour, examine relevant documents, classify cost information, including personal property and land improvements.
04
Arrive
At this point, we create a comprehensive report, including study results, methodology, property photos, and tax law support. This report becomes the basis of your audit defense.
Cost Segregation Frequently Asked Questions
Cost segregation is an IRS-approved tax strategy that allows property owners to accelerate depreciation by identifying and reclassifying certain building components into shorter recovery periods. Cost segregation separates qualifying property components into 5‑, 7‑, or 15‑year assets, increasing depreciation deductions in earlier years. Couple with bonus depreciation, a Cost Segregation tax strategy can produce significant depreciation deductions even in the first year the property was placed in service.
Any for-profit owner of real estate can potentially benefit from a Cost Segregation study:
- Businesses – businesses that own of commercial real estate, such as office buildings, manufacturing facilities, warehouses, healthcare facilities, self-storage, and other building types.
- Real Estate Investors – investors in commercial and residential real estate, including apartment buildings and short-term rental can significantly enhance their cash flow that can be reinvested into additional properties.
- High-Income Individuals – individuals in higher tax brackets who own real estate can benefit significantly from accelerated depreciation to reduce W-2 income.
Absolutely. The financial benefit depends most on the tax rate, timing, asset makeup, and how much income the property owner has to offset with the additional deductions.
A study typically takes 30-45 days to complete. With that said, a lot hinges on how quickly we can get the requested data and information from the client. More proactive clients can expect to receive the study results and final report within 10-15 days. Hull & Knarr will keep you up to date throughout the process and answer any questions you have regarding the services being conducted.
For a quick estimate of the potential financial benefit of a Cost Segregation study, feel free to use our online Cost Segregation estimator. Or, with the following additional information, Hull & Knarr can provide a more accurate estimate:
- Capitalized costs for your project
- Year that it was placed in service
- Depreciation schedule, if available
- Brief description of your business and/or the property use
- Square footage of the building
- Property address
The surest way to determine the value of a Cost Segregation study for your specific property and tax situation is to book a free consultation with our team. We can usually tell you within 15 to 30 minutes whether your property will yield meaningful value through a Cost Segregation study.
Yes. For properties that were placed in service and capitalized in previous years, Hull & Knarr will perform a lookback Cost Segregation study to identify, document, and calculate the catch-up adjustment. Using this methodology, the property owner doesn’t have to file amended returns to receive the financial benefit. The results of the Cost Segregation study (and the catch-up adjustment) are claimed on the current year’s tax return, saving time and money in the process.
Yes. Hull & Knarr provides free audit defense on every engagement. Well-documented Cost Segregation studies with detailed property identification and construction-related costs face minimal scrutiny.
Yes. Hull & Knarr works with your CPA and does not replace them. We work collaboratively with accounting firms to ensure proper documentation, compliance, filing, and the maximum benefit is achieved for their clients.
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