Short answer
A percentage is not evidence. "Apartment buildings are 25 percent short-lived property" tells you nothing about the building in front of you: its land share, its site work, whether its units are furnished, how its electrical and plumbing serve equipment rather than the structure, or what any of that cost. The IRS's Audit Techniques Guide describes the rule-of-thumb approach, which applies averages instead of property-specific analysis, as the least reliable method, and lists a described methodology, documentation, legal analysis, unit costs and take-offs, an asset list and reconciliation as the elements of a quality study. None of those can be produced from a percentage. This article explains why percentages fail, where they come from, and what a study does instead. It is general education, not tax advice.
Where the percentages come from
Every practitioner who has done a few hundred studies knows the rough range of results for a property type. Those ranges are the output of studies, averaged after the fact. They are useful for a sanity check: a result far outside the range deserves a second look. They are useless as an input, because an average of other buildings carries no information about the components of this one. Marketing that quotes a "typical" reclassification is quoting the output of other people's work as if it were a property of yours.
Why they fail as evidence
| What a study must show | What a percentage provides |
|---|---|
| Land separated from building by fair market value at purchase | Nothing; the percentage is usually applied to the price without a land split |
| An asset list: each component identified | Nothing; no components are identified |
| A legal reason for each classification | Nothing; no classification decision is made |
| A cost for each component from records or a documented estimate | Nothing; the percentage is the cost |
| Reconciliation to basis | Trivially true and meaningless: one number split by a ratio always adds up |
| Documentation an examiner can follow | Nothing to follow |
The guide's examination chapter tells examiners to request the study, the workpapers, the construction documents and the preparer's qualifications, and to examine the basis for classifications and costs. A percentage produces none of those documents. It is not that the examiner will disagree with the number; it is that there is nothing to agree or disagree with.
Why the law itself is item by item
The foundation case, Hospital Corporation of America v. Commissioner, decided the classification of specific building components on the facts and function of each item, allowing section 1245 treatment for some and denying it for others. The reasoning that has governed the practice since then is about what a particular item does: whether it serves the operation of the building or the operation of a business conducted in it. A percentage cannot ask that question about anything.
The same is true of cost. Two buildings of the same type and size can have different land shares, different site work, different finishes and equipment, different construction dates and different cost histories. A percentage assumes they are the same.
How a percentage distorts the result
Consider two apartment buildings bought for the same price in the same year. One sits on a large suburban lot with parking, site lighting, fencing and landscaped grounds, and its units are furnished. The other is a downtown building on a small lot with no site work to speak of and unfurnished units. A percentage applied to both produces the same reclassified amount. A study produces very different ones: the first has a modest land share, substantial 15-year land improvements and a meaningful 5-year line; the second has a large land share, almost no land improvements and little personal property. The percentage overstates the second building and understates the first, and in both cases it is wrong in a way nobody can check, because there is nothing behind it.
The distortion runs through the whole return. The reclassified amount drives the first-year deduction, which drives the passive loss, which drives the tax result the owner is told to expect. It also drives recapture years later, when the sale of components that were never identified has to be reported anyway. An error at the start is not confined to the start.
If you already have a percentage-based study
Owners sometimes discover, when a return is examined or a new adviser reads the file, that an earlier "study" was a percentage. The options are practical. Ask the original preparer for the workpapers; if there are none, you have your answer. Have a practitioner review the file against the elements the IRS guide lists and tell you what is missing. If the property still matters, a proper study can be prepared now and applied through the change-in-accounting-method rules with your adviser, which corrects the classifications going forward and computes the catch-up honestly. What does not work is defending the percentage on the ground that it was typical.
Where percentages hide
Rule-of-thumb work rarely announces itself. It shows up as:
- A "study" delivered from a questionnaire with no site visit, no drawings and no take-offs, whose asset list is suspiciously round.
- Component costs that are all fractions of the total rather than quantities multiplied by unit costs.
- A land split that is itself a percentage with no appraisal or assessor reference.
- Identical component ratios across different properties in the same practitioner's work.
- Software that "estimates" from property type and square footage and calls the result a study.
- A fee quoted before any document is seen, because the result is already known.
What replaces the percentage
- Basis and land. The closing statement, settlement costs and a documented land allocation.
- Identification. Drawings, records and a site visit to establish what components exist.
- Classification. A reason, grounded in the Code, regulations, guidance or case law, for each component's class.
- Cost. Actual records where they exist; where they do not, take-offs and documented unit costs for the location and date.
- Reconciliation. Allocated costs tied to basis, indirect costs allocated by a stated method, differences explained.
- The report. Methodology, assumptions, limitations, the asset list and the legal analysis, with the preparer identified.
The practical difference is time and evidence. A percentage takes an afternoon; a study takes weeks and produces a file. That is the trade.
The legitimate uses of ranges
Ranges are not worthless; they are just not a method.
- Screening. Before engaging a practitioner, an owner and an adviser can use typical ranges to judge whether a study is likely to be worth the fee for a property of a given basis and type, with the caveat that the actual result may fall outside the range.
- Sanity checks. A completed study whose result is far from the range for its property type should be explained. Sometimes the explanation is a furnished building with heavy site work; sometimes it is an error.
- Sampling on portfolios. The guide describes sampling and modeling approaches for large numbers of similar properties, under conditions and with documentation. That is a statistical method applied to a population, not a percentage applied to one building.
What people ask on Reddit and other forums
The searches that lead people to these threads are usually phrased "cost segregation percentage", "how much can be reclassified", "cost segregation rule of thumb".
The "cost segregation reddit" threads on r/realestateinvesting are full of quoted percentages. From the sources below:
"Everyone says 20 to 30 percent. Is that right for my building?" Nobody can know from a percentage. Land share, site work, furnishings and construction cost differ building by building. A study produces the answer; a percentage produces a guess.
"Is a rule-of-thumb study illegal?" No, but the IRS guide treats it as the least reliable approach, and it cannot answer what examiners are told to ask for.
"Can software estimate it from square footage?" That is a percentage with extra steps.
"My old study was a percentage. Now what?" Ask for the workpapers; have a practitioner review the file against the IRS guide's elements; if the property still matters, a proper study can be applied through the change-in-method rules with your adviser.
Questions people also ask
What percentage of a building can be reclassified?
There is no answer that applies to your building. The result depends on the land share, the site work, the personal property and the building's construction and cost. A study produces the answer; a percentage produces a guess.
Is a rule-of-thumb study illegal?
No. The IRS guide describes it as the least reliable approach and tells examiners what to ask for. The problem is evidentiary: a percentage cannot answer the examiner's questions.
Can software replace the study?
Software can organize a file and apply rules. Software that produces an asset list from property type and square footage is applying a percentage with extra steps.
Why do practitioners quote ranges if they are not a method?
Because they are useful for screening and sanity checks, and because prospective clients ask. A good practitioner quotes a range with the caveat and then does the work.
What should I ask if a practitioner gives me a number early?
What documents they have seen, what the land split is, and how the number was derived. If the answer is experience with similar buildings, you have been given a range, not a result.
Sources
- https://www.irs.gov/pub/irs-pdf/p5653.pdf — IRS Publication 5653, Cost Segregation Audit Techniques Guide (Rev. 2-2025): Chapter 3, methodologies; Chapter 4, principal elements; Chapter 5, examination.
- https://www.leagle.com/decision/1997130109btc211129 — Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997).
- https://www.irs.gov/publications/p551 — IRS Publication 551 (Rev. December 2024), Basis of Assets.