Cost segregation rests on the tax code's depreciation rules (Section 168), the line between personal property (Section 1245) and real property (Section 1250), the IRS's asset class lives in Revenue Procedure 87-56, and court cases such as Whiteco (1975) and Hospital Corporation of America (1997). The IRS's Cost Segregation Audit Techniques Guide explains how examiners apply all of it.
This content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.
Layer 1: The tax code
Section 168 (MACRS)
This section sets the recovery periods for depreciable property: 5, 7, 15, 27.5, and 39 years, among others. It's the foundation. Different property gets different lives by law.
Section 168(k) (bonus depreciation)
Allows an immediate deduction for qualifying property with a recovery period of 20 years or less. After the July 2025 law change, the rate is permanently 100% for property acquired after January 19, 2025.
Sections 1245 and 1250
- Section 1245 property is generally tangible personal property, like equipment, appliances, and certain fixtures.
- Section 1250 property is real property, like buildings and their structural components.
Cost segregation is largely about drawing the line between these two. The classification also controls how depreciation is recaptured when you sell.
Layer 2: IRS revenue procedures and regulations
Revenue Procedure 87-56
This IRS guidance lists asset classes and their class lives. For example, it assigns 15-year lives to land improvements and sets lives for assets used in specific industries, such as retail or restaurants. Studies cite these classes to support each classification.
Old investment tax credit rules
For decades, regulations written for the former investment tax credit defined "structural components" and "tangible personal property." Courts and the IRS still look to those definitions when deciding whether a component is part of the building.
Layer 3: Court cases
| Case | Year | Why it matters |
|---|---|---|
| Whiteco Industries v. Commissioner | 1975 | Set out factors for deciding whether property is "inherently permanent" or movable, such as how it's attached and whether it's designed to be moved |
| Hospital Corporation of America v. Commissioner | 1997 | The Tax Court allowed building components to be treated as personal property for depreciation, opening the door to modern cost segregation |
| AmeriSouth XXXIV v. Commissioner | 2012 | The Tax Court sided with the IRS on many apartment components, showing that weak classifications can fail |
The lesson from the cases: cost segregation is valid, but each classification must be supported by facts about how the component is attached and used.
Layer 4: The IRS audit guide
The Cost Segregation Audit Techniques Guide (Publication 5653) pulls all of this together for IRS examiners. First issued in 2004 and updated in 2022 and February 2025, it explains approved methods, quality standards, and industry-specific classification guidance. It isn't law, but it shows exactly how the IRS applies the law.
How a good study uses this authority
A quality report should cite the specific code sections, revenue procedure asset classes, and relevant cases behind its key classifications. If a report has numbers but no legal reasoning, it's missing one of the IRS's own quality elements.
Frequently asked questions
Is there one IRS rule that says "cost segregation is allowed"?
Why do old investment tax credit definitions still matter?
Does the IRS audit guide override the code?
See what your property may qualify for
Run our 2-minute STR Qualification Quiz or model your Low / Mid / High cost segregation range.
Related guides
Cost Segregation and the IRS: Is It Legal? Does It Raise Audit Risk?
Is cost segregation legal? Does it trigger an IRS audit? Here's how the IRS views cost segregation and what keeps a study on solid ground.
Read guideThe IRS Cost Segregation Guide (Publication 5653) in Plain English
The IRS Cost Segregation Audit Techniques Guide, Publication 5653, explained simply: what it covers, what changed in 2025, and why property owners should care.
Read guideIRS Cost Segregation Requirements: What a Quality Study Must Include
The IRS spells out what a quality cost segregation study looks like. Use this plain-English checklist to judge a study before you rely on it.
Read guideDepreciation Recapture: What It Is and How to Plan for It
Depreciation recapture taxes back some depreciation when you sell. Learn the 25% and ordinary rates, see an example, and explore ways to reduce or defer it.
Read guideThis content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.