There are a lot of promoters on the internet and tax articles that talk about Cost Segregation Studies aka “CSS” as the next big thing in tax planning.

Although there are potential big benefits from a Cost Segregation Study there are downsides too.

A CSS is performed by companies that specialize in this particular tax-planning technique.  When you contract with a CSS company, mechanical engineers and other professionals do a detailed analysis of your commercial real estate using architectural drawings, detailed construction analysis and observation to separate the cost of potential equipment from the total cost of your building.  By separating equipment out from building costs, you can reclassify construction costs to obtain a better depreciation deduction thereby lowering your taxes.

For instance, you construct a building or do a massive build-out to an existing building to build your restaurant.  The total cost is $1,000,000 which includes everything.  Typically, you are so busy  with construction quotes, costs and delays that you are dealing with large, summarized amounts.  You file your tax returns accordingly but several years later you have a CSS done.  The CSS finds, for example, that some wiring, hoods, HVAC, flooring, walls and other costs which you originally considered part of the building could theoretically be separated and defined as equipment.  The report is given to your accountant and your tax returns are changed to add bigger depreciation deductions thereby lowering your taxable income.

If you are dealing with large enough numbers the current tax benefit can be substantial.  You can even go back three years and amend prior tax returns getting refunds of previously paid taxes.

There can be several downsides though, that you should be aware of:

• The tax returns that are changed are open to audit and the IRS can dispute the analysis done by the company that performed the CSS.
• The company that performed the CSS may not be around when you get audited or may not have the expertise or wherewithal to handle an IRS audit.
• A CSS can be very costly to perform.  $10,000 to $40,000 is not out of the question.
• There are special tax forms your tax preparer is going to have to file and those fees could also be substantial.
• The CSS is a technique that accelerates your depreciation deduction into current years.  It does not create any new depreciation deductions.  In other words, over time you will still get the same depreciation deductions either way.  The CSS merely pushes it into current years reducing current year taxes.  You should consult with your tax advisor to decide whether it is more advantageous to receive the benefits now versus later.
• The new OBBB law passed in 2025 substantially liberalized depreciation deductions – see article in this newsletter – to the point that a CSS may not be all that advantageous to you.

If this is something you would like to explore in more detail, give Nick or Tony a call at Kallas.