Short answer

This glossary defines the terms that appear in cost segregation studies, depreciation schedules, projections and the questions people ask about them. Each definition is short and plain, and each is drawn from the IRS publications, the Code, the regulations, the Tax Court decision or the IRS Audit Techniques Guide listed under Sources. Where a term has a longer article on this site, the entry links to it. The glossary is general education, not tax advice, and the definitions describe federal rules; states differ.

Basis and cost

Basis. The amount invested in property for tax purposes, generally cost plus certain settlement costs, adjusted over time. Depreciation is computed from basis, and gain at sale is measured against it.

Adjusted basis. Basis after additions, such as improvements, and reductions, such as depreciation allowed or allowable.

Allowed or allowable. Basis is reduced by the depreciation you could have claimed whether or not you claimed it. Skipping depreciation does not preserve basis.

Capitalized basis. For constructed property, the total of direct and allocable indirect construction costs that must be capitalized rather than deducted.

Land allocation. The split of a lump-sum price between non-depreciable land and depreciable improvements, made by fair market value at purchase; assessed values may be used when values are uncertain. See Land and building allocation.

Settlement costs. Closing costs such as legal fees, recording fees, surveys, transfer taxes and title insurance that enter basis; loan costs do not.

Stepped-up basis. The basis of inherited property, generally its fair market value at the decedent's death. See Cost segregation when you inherit a property.

Indirect costs. Construction costs that attach to no single component, such as design fees, permits and general conditions, capitalized into basis and allocated across components by a stated method.

Depreciation mechanics

Depreciation. The annual deduction for the wear and tear, deterioration or obsolescence of property used in a business or income-producing activity.

MACRS. The modified accelerated cost recovery system, the method for most property placed in service after 1986, with fixed property classes, recovery periods, methods and conventions.

General depreciation system. The default MACRS system with the usual recovery periods: 27.5 years for residential rental property, 39 years for nonresidential real property, 15 years for land improvements, 5 and 7 years for most personal property.

Alternative depreciation system. The slower MACRS system required in some situations and available by election, with longer recovery periods.

Recovery period. The number of years over which a class of property is depreciated.

Property class. The grouping that determines the recovery period: 3-, 5-, 7-, 10-, 15-, 20-, 27.5- and 39-year property.

Placed in service. The date property is ready and available for its specific use; depreciation begins then. For a rental, ready and available for rent. See Acquisition date vs placed-in-service date.

Convention. The rule for how much of the first and last year counts: mid-month for real property, half-year or mid-quarter for other property.

Mid-quarter convention. Applies to non-real property when more than 40 percent of the depreciable basis of such property is placed in service in the last three months of the year.

Straight line. Equal annual depreciation over the recovery period; required for real property.

Declining balance. An accelerated method used for most shorter classes, switching to straight line when that yields a larger deduction.

Depreciation schedule. The asset-by-asset ledger behind Form 4562 showing basis, dates, classes, methods and accumulated depreciation. See How to read a depreciation schedule.

Form 4562. The return form on which depreciation, the section 179 deduction and the special depreciation allowance are reported.

Property classes and definitions

Residential rental property. A building or structure, including a mobile home, from which 80 percent or more of gross rental income comes from dwelling units; 27.5-year property.

Dwelling unit. A house or apartment used to provide living accommodations, excluding units in an establishment more than half of whose units are used on a transient basis.

Nonresidential real property. Depreciable real property that is not residential rental property; 39-year property.

Section 1245 property. Depreciable personal property and certain other property; on sale, gain is recaptured as ordinary income to the extent of depreciation.

Section 1250 property. Depreciable real property that is not section 1245 property; buildings and their structural components.

Structural component. Parts of a building such as walls, floors, roofs, windows, and the plumbing, electrical and HVAC that serve the building's operation, as distinguished from personal property serving a business function.

Land improvement. Depreciable improvements to land such as paving, fencing, sidewalks, drainage and certain landscaping; 15-year property.

Qualified improvement property. An improvement to the interior of a nonresidential building placed in service after the building, excluding enlargements, elevators, escalators and the internal structural framework; 15-year property. See Qualified improvement property and cost segregation.

Tangible personal property. Property other than land, buildings and their structural components; the target of most reclassification.

Unit of property. For the repair regulations, the building and its structural components as a single unit, with building systems analyzed separately.

Cost segregation practice

Cost segregation study. An analysis that identifies the components of a building and its site, classifies each into its property class with evidence and a legal reason, costs them, and reconciles the result to basis. See What a cost segregation study does.

Audit Techniques Guide. IRS Publication 5653, written for examiners, describing why studies are done, the methodologies, the elements of a quality study and how studies are examined.

Detailed engineering approach. The methodology that works from actual cost records with take-offs; the most accurate approach in the guide.

Engineering cost estimate. The methodology that measures quantities and prices them from documented unit costs when actual records are unavailable.

Residual estimation. Costing identified components and treating the remainder of basis as the building; acceptable when disclosed, unreliable when it hides missing components.

Sampling or modeling. A statistical approach for many similar properties, under conditions and with documentation.

Rule of thumb. Applying a percentage to the price; treated by the guide as the least reliable approach. See Why universal percentages fail.

Take-off. A measured quantity of a component from drawings or the site, used to price it.

Unit cost. The documented cost per unit of a component for a location and date, from records or a cost source.

Reconciliation. The tie of allocated costs, plus land, to the actual basis; the page reviewers read first. See How reconciliation reveals errors.

Asset list. The classified, costed list of components that the study produces and the depreciation schedule carries.

Legal analysis. The written reason, with authority, for each component's classification.

Preparer. The identified individual who prepared the study, with credentials and experience stated, as the guide's first element expects.

Look-back study. A study applied to property already in service through a change in accounting method. See Look-back studies and Form 3115.

Bonus depreciation, elections and method changes

Bonus depreciation. The additional first-year depreciation deduction for qualified property, generally property with a recovery period of 20 years or less; 100 percent for qualified property acquired after January 19, 2025. See Bonus depreciation and cost segregation after the 2025 law.

Qualified property. Property eligible for bonus depreciation, including used property acquired by purchase and not previously used by the taxpayer.

Acquisition date. For bonus depreciation, when the cost is paid or incurred, no later than a written binding contract date, or when construction begins for self-constructed property.

Transition election. The one-time election to apply a 40 percent rate, or 60 percent for certain property, instead of 100 percent for the first tax year ending after January 19, 2025.

Election out. The election not to claim bonus depreciation for a class of property placed in service in the year.

Section 179. An election to expense the cost of qualifying property used in the active conduct of a trade or business, subject to dollar and income limits. See Section 179 versus bonus depreciation.

De minimis safe harbor. An annual election to deduct tangible property costing up to a per-item threshold instead of capitalizing it. See The de minimis safe harbor.

Improvement. An amount paid for a betterment, restoration or adaptation of a unit of property, which is capitalized.

Partial disposition election. The election to treat the removal of a portion of an asset, such as a replaced roof, as a disposition and recover its remaining basis. See Cost segregation after a renovation.

Change in accounting method. The procedure, on Form 3115, for changing from an impermissible to a permissible method of depreciation, with a section 481(a) adjustment.

Section 481(a) adjustment. The catch-up amount that prevents duplication or omission when a method changes; negative when the taxpayer under-claimed depreciation.

Losses, sales and exchanges

Passive activity. A trade or business in which the taxpayer does not materially participate, and, in general, any rental activity; losses are limited to passive income.

Material participation. Involvement in an activity meeting one of seven tests, such as more than 500 hours. See Material participation for short-term rentals.

Active participation. A lower standard for rental real estate that qualifies an owner for the special allowance.

Special allowance. Up to $25,000 of rental real estate loss deductible against other income by active participants, phased out between $100,000 and $150,000 of modified adjusted gross income.

Real estate professional. A taxpayer who performs more than half of personal services and more than 750 hours in real property trades or businesses in which they materially participate; rental losses are not automatically passive. See The real estate professional test.

Suspended loss. A passive loss disallowed for the year and carried forward, released against passive income or on a fully taxable disposition. See Passive loss carryforwards.

Recapture. The treatment of gain attributable to depreciation on sale: ordinary income for section 1245 property; unrecaptured section 1250 gain at up to 25 percent for real property. See Depreciation recapture after cost segregation.

Unrecaptured section 1250 gain. The part of gain on real property attributable to straight-line depreciation, taxed at a maximum rate of 25 percent.

Like-kind exchange. An exchange of real property held for business or investment for like-kind real property under section 1031, deferring gain; structural components can be real property for this purpose even if section 1245 property for depreciation. See Cost segregation and a 1031 exchange.

Installment sale. A sale with payments in later years; section 1245 recapture is recognized in full in the year of sale regardless.

What people ask on Reddit and other forums

Many "cost segregation reddit" threads are vocabulary problems in disguise. The searches that lead people to these threads are usually phrased "cost segregation terms" and "depreciation terms explained".

"What's the difference between 1245 and 1250?" Section 1245 property is depreciable personal property and certain other property, recaptured as ordinary income; section 1250 property is depreciable real property, with unrecaptured gain at up to 25 percent.

"What does 'placed in service' actually mean?" Ready and available for its specific use, for a rental meaning ready and available for rent, whether or not rented.

"Is a suspended loss the same as a lost deduction?" No. It carries forward and is released against passive income or on a fully taxable disposition of the entire interest.

"What is a look-back?" A study applied to a building already in service, through Form 3115 and a section 481(a) adjustment, without amending prior returns.

Questions people also ask

What is the most important term to understand before a study?

Basis, because everything the study does reconciles to it, and the land allocation that comes out of it.

What is qualified property?

Property eligible for bonus depreciation, generally with a recovery period of 20 years or less; buildings are not qualified property.

What does a cost segregation study reclassify?

Components of a building purchase into 5-, 7- and 15-year classes from the 27.5- or 39-year building, with evidence and a legal reason for each.

What is the difference between a study and a depreciation schedule?

The study produces the classified asset list; the schedule is the ledger that carries it forward year by year.

Where do these definitions come from?

From the IRS publications, the Code, the regulations, the Tax Court decision and the IRS Audit Techniques Guide listed under Sources.

Sources