The tax mechanics: MACRS depreciation, methods, and conventions

• Under MACRS, the depreciation deduction depends on three parameters: the applicable depreciation method, the recovery period, and the convention. For most tangible personal property, the 200 percent declining balance method applies (with a switch to straight line when advantageous). Nonresidential real property and residential rental property use the straight line method. Recovery periods are set by statute—personal property generally ranges from 3 to 20 years; nonresidential real property is 39 years; residential rental property is 27.5 years. Conventions are generally half‑year for personal property and mid‑month for real property, with a mid‑quarter convention if more than 40% of basis is placed in service in the last quarter. Cost segregation moves qualifying assets out of the 39‑ or 27.5‑year buckets into shorter personal property or land‑improvement classes to accelerate deductions § 168(a), (b), (c), (d); Publication 946.

• Method and switching: Most personal property uses the 200 percent declining balance method with a switch to straight line when it yields a larger allowance, while real property uses straight line § 168(b).

• Recovery periods: Statutory recovery periods include 3, 5, 7, 10, 15, and 20 years for personal property; 27.5 years for residential rental property; and 39 years for nonresidential real property § 168(c).

• Conventions: Half‑year for most personal property; mid‑month for nonresidential and residential rental property; mid‑quarter can apply when more than 40% of basis is placed in service in the last quarter § 168(d).

What cost segregation reclassifies

A compliant study identifies building components and site work that qualify as § 1245 property (tangible personal property) or land improvements, separating them from § 1250 real property (structural components). Examples often include:

• Tangible personal property embedded in a building (for example, certain dedicated electrical, plumbing, or mechanical systems serving specific equipment) that qualifies for 5‑ or 7‑year recovery periods under MACRS classifications § 168(e).

• Land improvements (such as sidewalks, curbs, paving, landscaping, and certain site utilities), which are typically classified as 15‑year property § 168(e)(3)(E).

The study does not change total capital cost—rather, it allocates cost among shorter‑lived classes to accelerate depreciation. Because MACRS classification tables and definitions are statutory, reclassification must be supported by detailed engineering/architectural analysis and legal criteria, not merely accounting judgment § 168(e); Publication 946.

Qualified improvement property (QIP): a major acceleration opportunity

• For nonresidential buildings, “qualified improvement property” (QIP) is any improvement to the interior of a building made by the taxpayer and placed in service after the building was first placed in service, excluding enlargements, elevators/escalators, and the internal structural framework. The CARES Act clarified QIP as 15‑year property (20 years under ADS), restoring eligibility for bonus depreciation when other requirements are met. The change applies retroactively to improvements placed in service after December 31, 2017, enabling many taxpayers to accelerate deductions on interior nonstructural renovations (often captured by cost segregation or by a method change) § 168(e)(6); Rev. Proc. 2020‑25.

• CARES corrections: QIP is depreciated under GDS using straight line, a 15‑year recovery period, and the half‑year or mid‑quarter convention, as applicable; and under ADS using straight line, a 20‑year recovery period. If acquired and placed in service after September 27, 2017, QIP can be eligible for bonus depreciation assuming other § 168(k) criteria are met Rev. Proc. 2020‑25; § 168(k).

Bonus depreciation and cost segregation

• For qualified property, § 168(k) allows an additional first‑year depreciation deduction (bonus). Personal property with recovery periods of 20 years or less, QIP (as defined), and certain other classes can be eligible if acquisition and use requirements are met. By reclassifying assets into 5‑, 7‑, 10‑, or 15‑year buckets (or QIP), cost segregation increases the share of project costs that qualify for bonus depreciation. Bonus is taken after any § 179 expensing and before regular MACRS, further enhancing early deductions § 168(k)(1)–(2); Publication 946.

• Bonus mechanics: The full adjusted basis of qualified property can be deducted in the placed‑in‑service year (subject to eligibility and elections). Remaining basis (if any) is then depreciated under MACRS § 168(k)(1); Publication 946.

• Special 2025 election: For the first taxable year ending after January 19, 2025, taxpayers may elect a reduced bonus percentage (40% for general qualified property; 60% for certain long‑production‑period property and aircraft) when advantageous § 168(k)(10).

Note: Bonus eligibility has exceptions, including property required to be depreciated under ADS (for example, certain tax‑exempt use property). A compliant study and careful eligibility review are essential § 168(k)(2)(D).

Section 179 expensing vs. bonus depreciation

Although cost segregation pairs well with bonus depreciation, some taxpayers also consider § 179 expensing. Section 179 allows immediate expensing of qualifying property (subject to annual dollar limits, taxable income limits, and property‑type restrictions), and can include qualified improvement property as “qualified section 179 real property.” Plan the § 179 election and interaction with bonus on Form 4562; any disallowed § 179 amounts carry forward 2024 Instructions for Form 4562; Publication 946.

Compliance guardrails: capitalization vs. repairs, and documentation

Cost segregation addresses depreciation classification—not whether an expenditure is capital or deductible repair. Use the tangible property rules to determine capitalization versus repair treatment and then classify capitalized costs into appropriate MACRS classes. Proper documentation (invoices, engineering analyses, as‑built drawings, and tax‑law support) is critical to defend classifications and bonus eligibility Publication 946.

Implementing a cost segregation study

• Scope and data collection: Gather architectural plans, contracts, pay applications, change orders, and final cost reports; identify interior build‑out separate from shell/core; isolate site work. Use statutory MACRS tables and legal criteria to group costs into personal property, land improvements, QIP, and § 1250 real property § 168(e); Publication 946.

• Engineering analysis: Prepare a component‑level schedule showing asset descriptions, placed‑in‑service date(s), basis allocations, and MACRS class assignments. Apply correct methods and conventions (half‑year or mid‑quarter for personal property; mid‑month for real property) for accurate year‑one and ongoing computations § 168(b), (d); Publication 946.

• Bonus and elections: Determine bonus‑eligible classes and acquisition requirements; consider whether to elect out of bonus for any classes when planning future impacts. Document elections (or non‑elections) consistent with § 168(k) and the Form 4562 filing § 168(k); 2024 Instructions for Form 4562.

• Reporting and books: Post segregated assets to fixed‑asset subledgers; reconcile to total project cost. Complete Form 4562 with MACRS and bonus entries, and maintain workpapers supporting classifications and conventions Publication 946; 2024 Instructions for Form 4562.

Placed‑in‑service timing, changes in use, and method changes

Depreciation begins when the asset is placed in service. For retroactive corrections (such as reclassifying QIP or adopting cost segregation for prior‑year assets), a change in accounting method may be required (Form 3115) with a § 481(a) adjustment. IRS procedures allow corrections and certain late or revoked elections for QIP and § 168 elections; more generally, Publication 946 explains when to amend returns versus request consent to change accounting methods Rev. Proc. 2020‑25; Publication 946.

In addition, special rules apply if property changes use or is involved in like‑kind exchanges or involuntary conversions; MACRS regulations coordinate depreciation across dispositions and replacements to prevent distortion 26 CFR § 1.168(i)-6; Publication 946.

Recapture and disposition considerations

Accelerated depreciation increases ordinary income recapture for personal property and affects § 1250 outcomes for real property on disposition. Plan for recapture and maintain detailed subledger records to compute ordinary income and capital gain accurately Publication 544; Publication 946.

California nonconformity and state impacts

California often departs from federal depreciation rules (for example, special or bonus depreciation) and has different § 179 limits, requiring separate state computations and basis tracking. Taxpayers should evaluate current conformity (updated periodically by legislation) and maintain parallel ledgers to reconcile federal and California depreciation. For planning and compliance, consult FTB resources and guidance on current conformity and reporting requirements Tax News (Dec 2025) – Federal Conformity SB 711; Help with pass-through entity (PTE) elective tax.

Practical steps and best practices

• Use an engineering‑based study: Support classifications with detailed technical analysis and legal citations to MACRS classes; avoid “rule‑of‑thumb” allocations § 168(e).

• Tie out to contracts and as‑builts: Ensure total reclassified basis equals capitalized project cost; document placed‑in‑service dates for each component Publication 946.

• Plan elections and method changes: Coordinate § 168(k) elections, QIP retroactive corrections, and any Form 3115 filings to optimize current and future years Rev. Proc. 2020‑25.

• Track recapture: Maintain subledger detail to compute outcomes on sale; remember that accelerated and bonus depreciation affects “allowed or allowable” depreciation for recapture Publication 544.

• Manage state nonconformity: For California, compute depreciation under state rules and track differences; monitor conformity updates and reporting requirements Tax News (Dec 2025) – Federal Conformity SB 711.

Conclusion

Cost segregation accelerates depreciation by reclassifying building components and land improvements into shorter MACRS classes. When paired with qualified improvement property rules and bonus depreciation, early‑year tax savings can be substantial. A rigorous, well‑documented study aligned with MACRS classifications, § 168(k) bonus rules, and implementation/reporting procedures (including method changes when correcting prior years, recapture on disposition, and state nonconformity—especially in California) is essential. File elections and report depreciation on Form 4562 and applicable state forms to ensure complete compliance § 168; Rev. Proc. 2020‑25; Publication 946.