Cost Segregation Glossary
The terms a cost segregation study uses. Each legal term carries one statement checked against its primary source, with the citation beside it, and a link to the full rule; the three positions are our own definitions.
The Study
- Cost segregation
- The IRS guide describes a cost segregation study, for income tax purposes, as the allocation or reallocation of the total cost of property into the appropriate property classes and recovery periods so that depreciation is computed properly. Source: IRS Publication 5653 (Rev. 2-2025), chapter 3, part A, paragraph (1)
- Cost Segregation Audit Techniques Guide
- The IRS publishes its Cost Segregation Audit Techniques Guide as Publication 5653. The current revision is February 2025 (cover date 2-6-2025), and the IRS guide index lists its publication date as 02/2025. It predates the July 2025 law, so it does not describe the restored 100 percent bonus rate. Source: IRS Publication 5653 (Rev. 2-2025), Cost Segregation Audit Technique Guide, Catalog Number 20884M
- Conservative
- The lowest of the three shares of the building basis that our estimate moves to shorter depreciation lives. Source: SmartCostSeg definition
- Middle of the Road
- The middle of the three shares of the building basis that our estimate moves to shorter depreciation lives. Source: SmartCostSeg definition
- Aggressive
- The highest of the three shares of the building basis that our estimate moves to shorter depreciation lives. Source: SmartCostSeg definition
- Land allocation
- When a purchase price covers both land and buildings, the cost must be divided between them based on the fair market value of each at the time of purchase. If fair market values are uncertain, the IRS allows the split to follow the assessed values used for real estate tax. Source: Treas. Reg. section 1.167(a)-5; IRS Publication 527 (2025), chapter 2, Separating cost of land and buildings
- The three positions describe the building only. Land is carved out first and never depreciates, so the less of the price assigned to land, the more there is to depreciate: a low land value is the aggressive land position and a high land value is the conservative one. Source: SmartCostSeg definition
- Land improvements
- Land improvements fall in asset class 00.3 of Rev. Proc. 87-56, with a 20 year class life and a 15 year recovery period under the general depreciation system. Examples are sidewalks, roads, drainage facilities, fences and landscaping shrubbery. The class does not include buildings and structural components, or land improvements that another asset class explicitly includes, so a class for the business activity can set a different recovery period. IRS Publication 946, Appendix B lists the class in Table B-1. Source: IRS Publication 946 (2025), Appendix B, Table B-1; Rev. Proc. 87-56, 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22), asset class 00.3; IRS Publication 5653 (Rev. 2-2025), chapter 2, part L, paragraph (5); Rev. Rul. 2001-60
- Qualified improvement property
- Qualified improvement property is an improvement made by the taxpayer to the interior of a nonresidential building, placed in service after the building was first placed in service. It does not include enlarging the building, elevators or escalators, or the internal structural framework. Source: IRC section 168(e)(6)
Depreciation
- 5, 7 and 15 year property
- Under the general rule in section 168(e), property is 5 year property if its class life is more than 4 but less than 10 years, 7 year property if its class life is 10 or more but less than 16 years, and 15 year property if its class life is 20 or more but less than 25 years. The Code puts some property in a class by name, and property with no class life that is not otherwise classified is 7 year property. Source: IRC section 168(e)(1) and (e)(3)(C)(v)
- Residential rental property
- A building is residential rental property only if 80 percent or more of its gross rental income is from dwelling units. A dwelling unit does not include a unit in a hotel, motel or other establishment where more than one half of the units are used on a transient basis. Section 168 does not define transient basis or state a number of days. Source: IRC section 168(e)(2)(A)(i) and (ii)(I)
- Placed in service
- Depreciation begins when property is placed in service, which for a rental means when it is ready and available for rent, even if no tenant has moved in yet. Source: Treas. Reg. section 1.167(a)-10(b); IRS Publication 527 (2025), chapter 2, Placed in Service
- Bonus depreciation
- Qualified property gets a first year bonus depreciation allowance equal to 100 percent of its adjusted basis in the year it is placed in service. This is the Code text after the 2025 law, which applies to property acquired after January 19, 2025. Source: IRC section 168(k)(1)(A), as amended by P.L. 119-21 section 70301(b)(1)(A)
- Qualified property
- Bonus depreciation can apply to property that has a recovery period of 20 years or less, as long as the property also meets the other tests, such as the original use or used property rule. That covers the 5 year, 7 year and 15 year components a cost segregation study identifies. It does not cover the 27.5 year or 39 year building itself. Source: IRC section 168(k)(2)(A)(i)(I)
- Written binding contract
- Under the existing regulations that the notice carries forward, the acquisition date of property bought under a written binding contract is the latest of these dates: when the contract was entered into; when it became enforceable under state law; if the contract has cancellation periods, when all of them ended; and if the contract has contingency clauses, when all conditions subject to those clauses were satisfied. The regulation defines a contingency clause as one that provides for a condition or action within the control of any party or a predecessor. Source: Treas. Reg. section 1.168(k)-2(b)(5)(ii)(B), as described in IRS Notice 2026-11 section 2.03(2)(b) and applied by section 3.03
When You Sell
- Section 1245 property
- Section 1245 property is depreciable personal property plus certain other listed property. It generally does not include a building or its structural components. Since the 2025 law (Public Law 119-21), section 1245 property also includes qualified production property under section 168(n), which can be a building, when the taxpayer designates and elects it and places it in service after July 4, 2025. When section 1245 property is sold at a gain, the gain is ordinary income up to the depreciation allowed or allowable. Source: IRC section 1245(a)(1) and (a)(3); IRS Publication 544 (2025), chapter 3 and What's New
- Section 1250 property
- Section 1250 property is depreciable real property that is not section 1245 property. The most common example is a building and its structural components. Land itself is not included because it is not depreciable, but depreciable land improvements that are real property can be section 1250 property. Source: IRC section 1250(c); IRS Publication 544 (2025), chapter 3; IRS Publication 946 (2025), Appendix B, Table B-1
- Unrecaptured section 1250 gain
- The part of a long term gain on real property that comes from depreciation and is not recaptured as ordinary income is called unrecaptured section 1250 gain. It is taxed at a maximum rate of 25 percent. Source: IRC section 1(h)(1)(E) and (h)(6); IRS Tax Topic 409
Catching Up
- Change in accounting method
- Changing the depreciation method, period of recovery or convention of an asset for which a method has been adopted is a change in method of accounting. It therefore generally requires Form 3115 rather than an amended return. Before a method is adopted, an amended return can correct the depreciation. Source: Treas. Reg. section 1.446-1(e)(2)(ii)(d)(2)(i); IRS Publication 946 (2025), chapter 1
- Section 481(a) adjustment
- A negative section 481(a) adjustment, which lowers taxable income, is taken in full in the year of change. A positive adjustment is generally spread over four tax years. The adjustment for a depreciation change equals the difference between depreciation actually taken and depreciation allowable for all years before the year of change. Source: Rev. Proc. 2015-13, 2015-5 I.R.B. 419, section 7.03(1); Rev. Proc. 2025-23 section 6.01(5); IRS Publication 946 (2025), chapter 1
- Form 3115
- For an automatic change the original Form 3115 is attached to the timely filed federal income tax return (including extensions) for the year of change, and a signed copy is filed with the IRS no later than the date the original is filed. The IRS does not send acknowledgements for automatic change requests. The current Form 3115 instructions are the December 2022 revision. Source: Instructions for Form 3115 (Rev. 12/2022), When and Where To File; Rev. Proc. 2015-13 section 6.03(1)
Rentals
- Passive activity
- A passive activity is a trade or business in which the taxpayer does not materially participate, and it includes any rental activity except as provided for real estate professionals. An activity that falls outside the rental definition is tested under the material participation rules instead. Source: IRC section 469(c)(1) and (c)(2)
- Material participation
- An individual materially participates by meeting any one of seven tests: (1) more than 500 hours; (2) substantially all of the participation in the activity; (3) more than 100 hours and not less than any other individual; (4) significant participation activities totaling more than 500 hours; (5) material participation in any five of the ten preceding tax years; (6) a personal service activity with material participation in any three preceding tax years; (7) regular, continuous and substantial participation on the facts and circumstances. For income and loss from a limited partnership interest, an individual can use only the first, fifth and sixth of these tests. Source: Temp. Treas. Reg. section 1.469-5T(a)(1) through (7) and (e)(1) and (2)
- Average period of customer use
- Average period of customer use is worked out for each class of property. For a class, it is the total number of days in all periods of customer use divided by the number of those periods, counting only periods that end during the tax year or include its last day. An activity's average period of customer use is the sum of the class averages, each weighted by that class's share of the activity's gross rental income. The rule sits in the final regulation 1.469-1(e)(3)(iii); the matching paragraph of the temporary regulation 1.469-1T is reserved and points to it. Source: Treas. Reg. section 1.469-1(e)(3)(iii)(A) through (C); Temp. Treas. Reg. section 1.469-1T(e)(3)(iii) (reserved)
- Significant personal services
- An activity is also not a rental activity if the average period of customer use is 30 days or less and significant personal services are provided by or on behalf of the owner. Services similar to those commonly provided with long term rentals, such as cleaning common areas, routine repairs and trash collection, do not count. Source: Temp. Treas. Reg. section 1.469-1T(e)(3)(ii)(B) and (e)(3)(iv)
- Real estate professional
- A taxpayer meets the real property business tests, often called real estate professional status, for a year if more than one half of the personal services the taxpayer performs in trades or businesses during the year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of services during the year in those real property trades or businesses. Personal services performed as an employee are not treated as performed in a real property trade or business unless the taxpayer owns more than 5 percent of the employer. On a joint return, one spouse alone must meet both requirements, counting only that spouse's own services, although a spouse's work still counts in deciding whether the taxpayer materially participates in an activity. Meeting the tests only lifts the automatic passive treatment of rental real estate: the taxpayer must still materially participate in each rental real estate activity, or, if the taxpayer elects to treat all interests in rental real estate as one activity, in that single combined activity. Source: IRC section 469(c)(7)(A), (B) and (D)(ii); Treas. Reg. section 1.469-9(c)(4), (c)(5), (e)(1) and (g)
- Transient basis
- The 30 day figure comes from Treas. Reg. 1.48-1(h)(2)(ii), an investment credit regulation on hotel and motel property, not from section 168. It says accommodations are used on a transient basis if the rental period is normally less than 30 days. Paragraph (h)(1)(i) of the same regulation contains no 30 day language. Source: Treas. Reg. section 1.48-1(h)(2)(ii)
The rules on this page were checked against their sources on October 1, 2026.
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