Can I Do a Cost Segregation Study on a Property I Already Own?

Yes -- and this is one of the most underutilized opportunities in real estate tax planning. You do not need to have performed a cost segregation study in the year you purchased the property. The IRS allows you to apply a cost segregation study to a property you have owned for years and capture all of the missed accelerated depreciation in a single tax year through a change in accounting method filed on Form 3115.

The IRS Mechanism: Form 3115

When you perform a cost segregation study on a property you already own, you are changing your method of accounting for depreciation on certain components. Under Revenue Procedure 2015-13 (as updated by Rev. Proc. 2023-24), this type of change is filed under the automatic consent provisions using IRS Form 3115, Application for Change in Accounting Method. The designated change number (DCN) for depreciation method changes is typically DCN 7 under IRC Section 446(e).

The critical advantage is the IRC Section 481(a) adjustment. When you change your depreciation method, you calculate what your depreciation would have been if you had used the correct (reclassified) method from the start, compare it to what you actually claimed, and the difference -- called the Section 481(a) adjustment -- is taken as a deduction in the current year. There is no need to amend prior-year returns.

A Practical Example

Suppose you purchased a rental property five years ago for $600,000, with a depreciable basis of $480,000. You have been depreciating the entire building on a straight-line basis over 27.5 years, claiming approximately $17,455 per year in depreciation. A cost segregation study now identifies $144,000 (30%) as 5-year, 7-year, or 15-year property.

Under the correct depreciation method, those components would have been fully depreciated years ago (assuming bonus depreciation was available at the time of purchase). The cumulative depreciation you should have claimed on those components is $144,000 in Year 1 (at 100% bonus depreciation), but you only claimed $26,182 over five years on those same components using the 27.5-year schedule. The Section 481(a) adjustment -- the catch-up deduction -- would be approximately $117,818, all taken in the current tax year.

Key Requirements and Timing

Form 3115 must be filed with your timely filed federal income tax return (including extensions) for the year of change. You must also send a copy to the IRS national office. The form requires detailed information about the property, the old and new depreciation methods, and the computation of the Section 481(a) adjustment.

There is no statute of limitations issue because you are not amending a prior return -- you are making a prospective change in method with a current-year catch-up adjustment. This works regardless of whether the property was placed in service two years ago or twenty years ago. The IRS has specifically addressed this in multiple pieces of guidance, confirming that cost segregation studies applied retroactively through Form 3115 are permissible.

Properties That Benefit Most

Properties placed in service during tax years when bonus depreciation was available at high percentages (80% or above under IRC Section 168(k)) produce the largest catch-up deductions. Properties purchased before 2017, when bonus depreciation did not apply to used property, may generate smaller but still significant adjustments through MACRS accelerated methods (200% declining balance for personal property) versus straight-line depreciation.

The lookback study approach works for virtually any type of depreciable real property -- single-family rentals, apartment buildings, office buildings, retail spaces, restaurants, and medical facilities. If you own rental or commercial property and have never had a cost segregation study performed, the missed depreciation sitting in your property could represent tens of thousands of dollars in tax savings available to you this year.

Work with a tax advisor who understands both the engineering and the Form 3115 filing requirements to ensure the study and the method change are properly documented and defensible.

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This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified tax professional regarding your specific circumstances. AE Tax Advisors, 935 Lake Elmo Dr, Suite B, Billings, MT 59105. Phone: (631) 614-5762.