Why commercial buildings benefit more
Residential rental property depreciates over 27.5 years with relatively few components that qualify for faster depreciation under MACRS. Commercial buildings depreciate over a longer 39-year period, which makes reclassification even more valuable: shaving something from 39-year to 5-year life is a bigger acceleration than from 27.5 to 5.
Commercial properties also tend to contain more eligible components. A retail buildout includes specialty plumbing, electrical, flooring, and decorative finishes that can be 5- or 7-year property. An office building may have raised floors, server rooms, and partitions. A warehouse commonly has loading docks, cranes, and process-related equipment. Studies on commercial properties routinely reclassify 25–40% of the depreciable basis into shorter-life assets, compared to 15–25% for residential.
The 39-year baseline amplifies savings
Start at 39 years and a $2 million building generates about $51,000 per year in straight-line depreciation ($2M ÷ 39). If a cost segregation study reclassifies $600,000 into 5-, 7-, and 15-year property and bonus depreciation applies at even 40%, the first-year deduction on that reclassified portion is $240,000. That compares to only $15,385 per year that the same $600,000 would have generated under the 39-year schedule. The acceleration is dramatic, and it all deducts against ordinary income.
Practical considerations
For commercial properties, the cost of the study itself is typically well justified — studies on properties valued above $1 million almost always pencil out. The recapture tradeoff applies here too: components reclassified to personal property (Section 1245) recapture at ordinary income rates when you sell, versus the capped 25% on Section 1250 (real property) recapture. Factor that in before sale, and consider a 1031 exchange if recapture would be large.
Frequently asked questions
Is cost segregation more valuable for commercial or residential?
Commercial, in most cases. The 39-year baseline is slower, so acceleration produces a larger benefit. Commercial properties also tend to have more reclassifiable components.
What percentage of a commercial building gets reclassified?
Studies on commercial buildings commonly reclassify 25–40% of the depreciable basis into 5-, 7-, or 15-year property, though the actual percentage varies with property type and buildout.
Does Section 1245 recapture apply to commercial cost segregation?
Yes. Components reclassified to personal property (5- or 7-year) are Section 1245 property and recapture at ordinary income rates when you sell, not the 25% cap that applies to real property.
Sources
- IRS Publication 946 — How to Depreciate Property
- IRS — Cost Segregation Audit Techniques Guide
- IRS Publication 527 — Residential Rental Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.