Depreciable Basis Explained
Depreciable basis is the amount you can depreciate: generally your cost for the property, minus land, adjusted for improvements and prior depreciation. A cost segregation study allocates that number. It does not increase it. Gift, inheritance, and exchange basis rules can change the starting figure.
Educational information, not tax advice.
Updated 2026-10-14
Key takeaways
- Basis generally starts with cost under §1012.
- Land value must be removed because land is not depreciable.
- A cost segregation study allocates depreciable basis; it does not increase it.
- Basis later increases with capital improvements and decreases by depreciation allowed or allowable.
- Gift, inheritance, and exchange basis rules can change the starting number and need CPA review.
Under §1012, the basis of property is generally its cost. For a purchased building, cost includes the price paid and certain acquisition costs. IRS Publication 527 lists settlement fees and closing costs, such as legal and recording fees, title insurance, and surveys, as items that are generally added to the basis of rental property. Your CPA confirms which costs apply to your purchase.
From that total, the portion attributable to land is removed. What remains is the depreciable basis of the building and its improvements. Over time, basis increases with capital improvements and decreases with depreciation allowed or allowable.
Section 167(c) says the basis for depreciation is the adjusted basis used to measure gain on a sale. That is why depreciation and sale computations stay linked. Taking more depreciation now reduces the gain-or-loss basis later.
A study that “finds” extra depreciable basis by ignoring land, double-counting furniture bought separately, or stepping estimates up to a hopeful number is not allocating cost. It is inventing it. The IRS audit guide treats failure to reconcile to actual cost as a weakness.
Special basis rules for gifts, inheritances, and like-kind exchanges are only sketched here. Educational information, not tax advice.
Land comes out first. Capital improvements added later have their own basis and their own placed-in-service dates. Each year’s depreciation, including depreciation that was allowable but not claimed, reduces adjusted basis. A study only assigns what is already in that depreciable remainder. It does not create a larger remainder.
Where cost segregation fits
A study takes the depreciable basis as its starting point and divides it among recovery classes. The sum of all classes must reconcile to that basis. The IRS audit guide treats a failure to reconcile allocated costs to actual costs as a weakness in a study.
If furniture, appliances, or other personal property were bought on separate invoices and already have their own basis, those invoices should not be priced again inside the building allocation. Double-counting separately acquired FF&E is a listed quality problem in the guide. The study’s job is to split the building’s depreciable remainder, not to recreate a furniture invoice that already has its own Form 4562 line.
Indirect costs that are already in project basis — design fees, permits, capitalized interest — should be allocated across components. Leaving them all on the 39-year line understates the shorter classes and overstates the building.
Inherited, gifted, and exchanged property
Basis rules differ for property received by gift, inheritance, or a like-kind exchange. Those situations change the starting number and sometimes the depreciation method, and they need your CPA's review before a study.
This article does not restate the full basis-computation rules for those transfers. The research register notes that the appropriate allocation method when §1060 does not apply was not established from an official source in the October 2026 session beyond cost, relative values, and the Publication 527 assessed-value note.
If the property’s basis is carryover or substituted, bonus depreciation and §179 can also be limited. Related-party and carryover-basis acquisitions are a separate eligibility question.
Allowed or allowable
Basis is reduced by depreciation that was allowable even if it was not claimed. That is one reason a look-back study is implemented through an accounting method change rather than by simply amending to a new classification.
“Allowable” follows the method the law required for the class the taxpayer used, or should have used, in those years. Catch-up depreciation is computed from that history, not from today’s bonus rate applied as if the property were new.
A negative §481(a) adjustment is the usual way the missed amount is taken when the change is from an impermissible to a permissible method. Your CPA selects the designated change number.
Improvements after purchase
Capital improvements added after the original placement have their own placed-in-service dates and their own depreciable basis. They are not folded back into the original building’s remaining basis as if they had always been there.
Whether later work is a capital improvement or a deductible repair is decided under Treas. Reg. §1.263(a)-3. A renovation study has to answer that question before it classifies the capitalized remainder.
What a study cannot do to basis
It cannot depreciate land. It cannot treat a purchase-price residual as extra building cost without an explanation. It cannot use a uniform step-up factor to force estimates to the price.
It also cannot change a written §1060 allocation that binds the parties unless the IRS determines the agreement is not appropriate. See the purchase-price allocation article and Peco Foods. Those limits are why the study starts from basis the CPA already accepts, not from a hoped-for depreciable total.
Sources
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- 4IRS Publication 946 — How To Depreciate Property (2025)(opens in a new tab)
Appendix B reproduces the Rev. Proc. 87-56 class lives.
- 5IRS Publication 5653 — Cost Segregation Audit Techniques Guide (rev. 2-2025)(opens in a new tab)
Written for IRS examiners. The guide states it is not an official pronouncement of law and cannot be cited as authority. It predates the July 2025 law.
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