The lookback cost segregation study
If you have owned a property for several years and never had a cost segregation study performed, you have likely been under-depreciating. A lookback study reclassifies assets from the original placed-in-service date as if the study had been done then. The engineer computes the depreciation that would have been claimed under the corrected classification and compares it to what was actually claimed.
Catching up with Form 3115
The difference between what was claimed and what should have been claimed is recovered as a Section 481(a) adjustment filed on Form 3115 (Application for Change in Accounting Method) with the current year's tax return. You do not amend prior-year returns — the entire accumulated catch-up comes through in a single deduction in the current year. For a property held several years with significant accelerated components, this can be a substantial six-figure deduction.
What to watch for
The catch-up deduction creates a large paper loss subject to passive activity loss (PAL) rules. Unless you have passive income to absorb it, qualify as a real estate professional, or hold the property as a non-passive short-term rental, the losses may be suspended. Also consider recapture at sale: components reclassified to personal property (Section 1245) are taxed at ordinary rates when sold. Model the full picture with a CPA before commissioning the study.
Frequently asked questions
Can I do a cost segregation study on a property I bought five years ago?
Yes — a lookback study reclassifies from the original placed-in-service date, and the catch-up is claimed in the current year via Form 3115, not by amending prior returns.
How large can a lookback catch-up deduction be?
It depends on the property value and hold period. A $1M commercial building held for 5 years without a study might generate a six-figure catch-up deduction in a single year.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.