Frequently Asked Questions

Failing to file Form 3115 when required can have several negative consequences for your tax situation and long-term financial strategy. If you implement a cost segregation study without properly notifying the IRS through Form 3115, you risk having the accelerated depreciation deductions disallowed during an audit, potentially resulting in back taxes, interest, and penalties. The IRS views unauthorized accounting method changes as non-compliance, which can trigger increased scrutiny of your returns.

Without filing Form 3115, you also miss the opportunity to claim the Section 481(a) adjustment that captures all prior years' missed depreciation in one year, essentially leaving significant tax benefits on the table. Additionally, if the IRS discovers the inconsistency between your depreciation methods across years, they may require you to file the form anyway, but under examination procedures rather than automatic consent, which is more complex and potentially costly.

You might also face accuracy-related penalties if the IRS determines you should have known about the filing requirement. Perhaps most importantly, without proper documentation through Form 3115, you lack the clear paper trail demonstrating IRS compliance, which could complicate future property sales, refinancing, or additional tax planning strategies.

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Absolutely. Form 3115 is the essential bridge that allows you to implement cost segregation benefits when you've already been depreciating your property using standard straight-line methods. After completing a cost segregation study that identifies components eligible for shorter depreciation periods, Form 3115 enables you to formally change your depreciation method from straight-line to the accelerated method identified in the study. This change allows you to reclassify various building components into 5-, 7-, and 15-year property categories rather than the standard 27.5 or 39 years.

The most powerful aspect of Form 3115 is the Section 481(a) adjustment, which captures all the additional depreciation you would have claimed in prior years had you used cost segregation from the beginning. This means if you've owned a property for five years and just completed a cost segregation study, you can claim five years' worth of missed accelerated depreciation in the current tax year. This front-loading of deductions can create significant tax savings and improved cash flow, making Form 3115 an invaluable tool for maximizing the benefits of your cost segregation study.

The form essentially allows you to correct your depreciation method going forward while catching up on past benefits, all without the complexity of amending previous returns.

Real estate investors need to file IRS Form 3115, Application for Change in Accounting Method, when they're changing how they depreciate their property, most commonly after completing a cost segregation study on a property they've owned for more than one tax year. If you've already filed tax returns using straight-line depreciation and now want to implement accelerated depreciation based on a cost segregation study, Form 3115 formally notifies the IRS of this accounting method change. The form allows you to claim all previously unclaimed depreciation through a Section 481(a) adjustment in the current year, effectively catching up on years of missed accelerated depreciation without the need to amend prior returns.

This is particularly valuable because amending returns can trigger additional scrutiny, has statute of limitations restrictions, and requires significantly more paperwork. Form 3115 also helps correct past depreciation errors, such as using the wrong recovery period or failing to claim depreciation altogether. The automatic consent procedures for many common changes mean you don't need IRS pre-approval, making the process relatively straightforward. Filing this form ensures full compliance with IRS regulations while maximizing your legitimate tax deductions, protecting you from potential penalties or disputes during an audit.

As a high W-2 earner, your ability to use rental property losses from cost segregation to offset wages depends on specific IRS rules regarding passive activities. Generally, rental activities are considered passive, and passive losses cannot offset active income like W-2 wages unless you qualify for specific exceptions.

The most comprehensive exception is achieving Real Estate Professional status, which requires spending more than 750 hours annually and more than half your total working time in real estate activities, plus materially participating in your rental properties. This is often difficult for high W-2 earners with full-time jobs to achieve. However, a more accessible option for many is the short-term rental exception (also known as the short-term rental loophole).

If your property has an average guest stay of 7 days or less, it's not considered a passive rental under IRS rules. By materially participating in the property's operation, which can be achieved through various tests including working 100-plus hours annually with no one else participating more, you can treat the income and losses as active, allowing offset against your W-2 income. The $25,000 active participation exception for long-term rentals phases out completely at $150,000 of modified adjusted gross income, making it unavailable to most high earners.

Even if you can't immediately use the losses against W-2 income, cost segregation still provides value by creating suspended passive losses that offset future passive income, reduce taxable rental income in profitable years, and become fully deductible when you sell the property. We strongly recommend consulting with a qualified tax advisor to determine your specific eligibility and develop the optimal strategy for your situation.

If you're planning to sell your property in the near future, the decision to pursue cost segregation requires careful consideration of depreciation recapture rules. When you sell a property after taking accelerated depreciation, you'll face recapture tax on the difference between accelerated and straight-line depreciation at ordinary income rates, which can be as high as 37%.

This recapture can significantly reduce or eliminate the benefits of cost segregation if the sale occurs too soon. We generally recommend holding a property for at least 3-5 years after performing cost segregation to ensure the time value of money and tax deferral benefits outweigh the eventual recapture tax. The exact break-even point depends on your tax rates, the amount of accelerated depreciation, and your cost of capital.

However, if you're planning a 1031 like-kind exchange rather than a taxable sale, cost segregation becomes much more attractive. In a 1031 exchange, you defer the recapture tax by rolling the basis into your replacement property, allowing you to continue benefiting from accelerated depreciation without immediate tax consequences. Even if you're selling within 2-3 years, cost segregation might still make sense if you're in a high tax bracket now but expect lower rates at sale, or if the property has minimal personal property that would be subject to higher recapture rates.

You can perform a look-back cost segregation study on properties acquired as far back as 1987, when the current depreciation rules under MACRS went into effect. Through filing Form 3115 for an automatic accounting method change, you can claim all the accumulated missed depreciation as a Section 481(a) adjustment in the current tax year without amending any prior-year tax returns.

This means if you've been depreciating a property using straight-line depreciation for several years, you can still capture the benefits of accelerated depreciation you would have received had you performed cost segregation from the beginning. However, there are diminishing returns the longer you've owned and depreciated a property. Properties owned for more than 15 years may have limited remaining benefits, especially if they've already been substantially depreciated. The cost-benefit analysis becomes less favorable as the remaining depreciable life decreases, though high-value properties or those with significant improvements may still justify the study cost.

The optimal time to perform a cost segregation study is within the tax year that the building is purchased, constructed, or substantially renovated. This timing allows you to maximize first-year depreciation benefits without needing to file additional forms with the IRS. When you conduct the study in the same year as acquisition or placement in service, you simply use the accelerated depreciation schedule from the start, avoiding the need for Form 3115 to change accounting methods.

However, this doesn't mean you've missed the opportunity if you've owned the property for several years. Look-back studies can capture missed depreciation from prior years through a Section 481(a) adjustment, bringing all that accumulated benefit into the current tax year. The key is completing the study before filing your tax return for the year you want to claim the benefits. For specific tax deadlines, we maintain strict cut-off dates to ensure quality delivery.

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We pride ourselves on offering affordable cost segregation studies tailored to every budget and property type. Our self-directed Rapid Report, designed for smaller residential properties up to 4 units with a depreciable basis under $800,000 and capital improvements under $50,000, is available for $950.

For properties that don't meet these criteria and/or require more detailed analysis, our Fully Engineered Study starts at $2,800 for residential properties and $3,325+ for commercial properties. The final fee varies based on square footage, property type, and complexity of the analysis required. Rush service pricing for pending tax deadlines may apply and are subject to capacity availability.

Both services include full IRS audit protection and are performed by qualified engineers following IRS guidelines. To understand exactly what a cost segregation study on your investment property would cost, we provide free proposals that include fee quotes along with estimated depreciation benefits, allowing you to evaluate the return on investment before committing to the study.

Compare our cost segregation study services or request a free proposal for your property here.