Real Estate Tax Calc
Why new construction is ideal for cost segregation
When you buy an existing building, the cost segregation engineer must allocate a single purchase price among land, building, and components using appraisal techniques, comparable cost databases, and unit-cost estimates. On a new construction project, the construction draw records itemize every cost: foundation, framing, electrical, plumbing, finishes, and site work. This documentation allows more precise classification with less estimation.
The result: cost seg studies on new construction typically identify a higher percentage of qualifying shorter-life assets than studies on acquired buildings, because there is no need to back-allocate from a lump-sum price.
What gets reclassified in a commercial build
In a typical new commercial building, cost segregation can identify: 5-year personal property (carpeting, certain flooring, removable fixtures, specialized equipment); 7-year personal property (office furniture and fixtures); and 15-year land improvements (parking lots, sidewalks, landscaping, fencing, exterior lighting). In residential rentals, 15-year land improvements are the main accelerant. With 100% bonus depreciation available for property with a 20-year or shorter MACRS life, all of these components can be expensed in year one.
Timing: do the study before filing
A cost seg study on a new construction project should be completed and reviewed before you file your first-year tax return. If you miss the first-year return, you can use Form 3115 (change in accounting method) to catch up the missed depreciation in a subsequent year, but it adds complexity. Engaging the engineer during or shortly after construction completion minimizes this risk.
A worked example on a new build
Suppose you complete a small apartment building with a total depreciable basis of $2,500,000 (land excluded). On a straight-line 27.5-year schedule, first-year depreciation would be roughly $91,000. A cost segregation study on the new construction identifies 22% of the basis — $550,000 — as 5-, 7-, and 15-year property, aided by the precise construction records.
With 100% bonus depreciation for qualified property placed in service after January 19, 2025, that $550,000 is deductible in year one, alongside the first-year depreciation on the remaining $1.95M shell. Your first-year deduction jumps from about $91,000 to well over $600,000. At a 35% combined marginal rate, that is roughly $180,000 of tax deferred into the first year — a powerful boost to cash flow right when a new project is stabilizing.
The construction cost segregation approach
On an acquired building, the engineer works backward from a single purchase price. On a new build, the engineer works forward from actual costs. The best evidence comes from the general contractor's schedule of values, AIA pay applications, and draw requests, which break the project into line items — sitework, concrete, framing, electrical, plumbing, HVAC, finishes, and so on. Each line can be mapped to its correct MACRS class with far less estimation than an appraisal-based allocation.
This is why builders and developers often engage the cost segregation firm during construction. Capturing costs contemporaneously — including change orders and soft costs that get capitalized into basis — produces the most accurate and defensible classification. If you wait years and the contractor records are gone, the study reverts to estimation and loses some of its new-construction advantage.
Watch the passive activity loss rules
A six-figure first-year deduction usually creates a paper loss, and for most owners rental real estate is a passive activity. Passive losses can offset only passive income — not wages or portfolio income — unless you qualify as a real estate professional and materially participate, use the $25,000 special allowance (which phases out between $100,000 and $150,000 of modified AGI), or operate a short-term rental with material participation.
If none of those apply, the loss is suspended and carried forward until you have passive income or dispose of the property. That does not waste the deduction, but it does delay the benefit — so confirm you can actually use a large first-year loss before you pay for the study. Developers who also earn active real estate income are frequently the biggest winners here.
Recapture when you eventually sell
Cost segregation is a deferral, not a permanent tax cut, and it changes the character of your gain at sale. The 5- and 7-year personal property is subject to Section 1245 recapture — depreciation on those items comes back as ordinary income up to the amount taken. The 15-year land improvements and the building fall under Section 1250, with the building's straight-line depreciation recaptured as unrecaptured Section 1250 gain taxed at up to 25%.
So a study trades some future 25% Section 1250 recapture for ordinary-rate Section 1245 recapture, while giving you the time value of accelerated deductions now. A 1031 exchange at sale can defer that recapture entirely, which is why buy-and-hold developers who chain exchanges capture the most lifetime value from an aggressive first-year study.
Timing, developers, and common mistakes
The controlling date for bonus depreciation is when the property is placed in service — ready and available for its intended use, typically when you obtain the certificate of occupancy and the units are available to rent, not when construction merely finished. Plan the study around that date so the deductions land in the year you want them, and coordinate with your CPA if the project straddles two tax years.
Common mistakes on new construction include forgetting to capitalize soft costs into the reclassified components, mixing land-clearing costs (nondepreciable land) with depreciable land improvements, and letting contractor records disappear before the study is done. If you missed the study on a build you completed in an earlier year, a Form 3115 change in accounting method lets you catch up all the missed accelerated depreciation in the current year without amending prior returns.
What typically gets reclassified in a new build
A new-construction study sorts the project into recovery classes. 15-year land improvements are usually the largest bucket on a residential project: parking and driveways, sidewalks, curbing, retaining walls, site drainage, landscaping and irrigation, exterior lighting, fencing, and signage. On residential rentals these site costs are often the primary source of acceleration because the building interior has fewer 5-year items than a commercial space.
5-year personal property includes carpeting and certain floor coverings, cabinetry and countertops not treated as building structure, decorative lighting, appliances, window treatments, and specialty electrical serving specific equipment. 7-year property covers landlord-owned furniture and fixtures in leasing offices and amenity spaces. The engineer measures and prices each from the construction records, which is exactly why a new build classifies more cleanly than an acquisition.
Soft costs and indirect costs
A frequently missed advantage of new construction is that indirect and soft costs get allocated across the reclassified components rather than defaulting entirely to the 27.5- or 39-year shell. Architectural and engineering fees, permits, general conditions, contractor overhead and profit, and construction-period interest are all capitalized into basis. A proper study spreads these proportionally, so a portion of every soft-cost dollar rides along with the 5- and 15-year property and accelerates with it.
On a large project this reallocation is worth real money. If soft costs run 15–20% of a build and a fifth of the hard costs are short-life, allocating the matching share of soft costs to those components can add several percentage points to the total accelerated basis — value that a desktop, hard-cost-only estimate leaves on the table.
When new-construction cost segregation is worth it
The decision follows the same logic as for acquisitions: compare the study fee against the present value of the tax you defer. For most new builds the answer is favorable once depreciable basis clears roughly $500,000 and you intend to hold the property for several years. Below that, a low-cost report or the IRS class-life tables may make more sense than a full engineered study.
Two factors push the economics strongly in favor of a study on new construction: the availability of 100% bonus depreciation for components placed in service after January 19, 2025, and the precision of contemporaneous construction records, which both maximizes the reclassified percentage and strengthens audit defense. If you are building and can use the deduction, engaging the engineer early is usually one of the highest-return tax moves available to a developer.
Frequently asked questions
Is cost segregation only for acquisitions, or does it work for new builds?
It works for both, and often provides more precise results on new builds because all costs are itemized in construction records.
What records make a new-construction study most accurate?
The general contractor's schedule of values, AIA pay applications, draw requests, and change orders. Contemporaneous cost detail lets the engineer classify components directly instead of estimating.
When is a new building considered placed in service?
Generally when it is ready and available for its intended use — typically the certificate of occupancy and availability to rent — which is the date that controls first-year and bonus depreciation.
Can I still do a study if I finished the building last year?
Yes. A Form 3115 change in accounting method lets you claim all the missed accelerated depreciation in the current year, with no amended returns required.
Do soft costs benefit from cost segregation on a new build?
Yes. Architectural and engineering fees, permits, general conditions, overhead, and construction-period interest are capitalized into basis, and a proper study allocates a proportional share of them to the 5- and 15-year components so they accelerate too.
Which components make up most of a residential new-construction study?
Usually the 15-year land improvements — paving, sidewalks, drainage, landscaping, exterior lighting, and fencing — along with 5-year items like carpeting, appliances, and specialty electrical.
How much of a new building's cost can be reclassified?
It varies by building type and design, but residential rentals typically see 10–20% of depreciable basis reclassified; commercial buildings 15–30%. A cost segregation engineer will provide a range before completing the study.
Can I use bonus depreciation on reclassified new construction components?
Yes. Property with a MACRS life of 20 years or less — including the 5-, 7-, and 15-year components identified by cost segregation — qualifies for 100% bonus depreciation for qualifying property placed in service after January 19, 2025.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.