🇺🇸 Made in America·100% U.S.-Based Team · 24+ Years in Cost Segregation
A restaurant is one of the strongest candidates for a cost segregation study of any commercial property type, because so much of what you paid for sits outside the structure: the dedicated electrical and gas service that runs to the cooking line, the plumbing that feeds the dish pit and the beverage stations, the walk-in coolers, the hood and exhaust equipment, the booths, the bar, the decorative lighting, the flooring, the point-of-sale cabling, the drive-thru lane, the patio, the parking lot, and the signage out front. Under the standard approach, all of that is lumped into a single 39-year building and depreciated at roughly 2.5 percent per year. A fully engineered and accounted cost segregation study separates those components and assigns each the shorter recovery period the tax code already gives it, usually 5, 7, or 15 years. Because the One Big Beautiful Bill Act made 100 percent bonus depreciation permanent for qualifying property acquired and placed in service after January 19, 2025, the reclassified portion can often be deducted in the first year.
The catch comes first. The study creates the deduction; your tax situation determines how much of it you can use this year. For restaurant owners who also own the building, a specific set of rules can trap the loss or free it, depending on how the entities are set up and what your CPA elects.
Ingrid is an illustration, so you can follow the math.
In August 2026, Ingrid buys a freestanding 4,200 square foot restaurant building in Macon, Georgia with a drive-thru lane, a covered patio, and a 40-space parking lot for $2,000,000. She operates a fast-casual concept inside it through her operating company and holds the real estate in a separate LLC that leases the building to the restaurant. Her closing attorney and CPA allocate $400,000, or 20 percent, to land, leaving $1,600,000 of depreciable basis.
Without a cost segregation study, her CPA depreciates the entire $1,600,000 as a single 39-year asset. The IRS mid-month table rate for an August placed-in-service date on 39-year property is 0.963 percent, so that produces $15,408 of depreciation in 2026, and about $41,026 a year after that.
With a study, our team performs a component-by-component analysis of the purchase documents, drawings, and property records and classifies each element. In this illustration the study reclassifies 35 percent of the depreciable basis, or $560,000, out of the 39-year bucket: $350,000 to 5-year property (dedicated electrical and gas to the cooking line, plumbing serving equipment and beverage stations, decorative lighting, booths and millwork, flooring, data and point-of-sale cabling, security and sound systems) and $210,000 to 15-year land improvements (parking lot, drive-thru lane, patio paving, sidewalks, landscaping, exterior lighting, and site utilities). The remaining $1,040,000 stays in the 39-year building.
Because the property was acquired and placed in service after January 19, 2025, the reclassified $560,000 qualifies for 100 percent bonus depreciation. Ingrid deducts the full $560,000 in 2026, with no proration, plus $10,015 of 39-year depreciation on the building at the August rate, for a total of $570,015. Compared with the $15,408 she would have claimed without the study, the incremental first-year deduction is $554,607.
Ingrid and her husband file jointly, and his salary keeps the household in the 37 percent federal bracket even after the loss. The restaurant and the building together earn about $350,000 before depreciation, so with the grouping election described below the study turns that into a net business loss of about $220,000, which sits under the Section 461(l) cap on her 2026 return of $512,000 for joint filers ($256,000 single, adjusted annually). If she can use the deduction in full, the $554,607 is worth roughly $205,000 of federal tax deferred in year one. The percentage reclassified varies by restaurant, and the benefit is a timing advantage with recapture we cover below.
Cost segregation is a fully engineered and accounted analysis of what you paid for a property, broken into its components, with each component assigned to the correct tax recovery class. Section 1250 property generally means the building and its structural components. Section 1245 property generally means tangible personal property, which carries shorter recovery periods, and it includes certain items that serve equipment or a business function rather than the operation and maintenance of the building itself. Land improvements such as paving, fencing, and site lighting are classified separately and generally carry a 15-year recovery period. The Tax Court addressed how to tell a structural component from personal property in Whiteco Industries and, in a decision that matters enormously for restaurants, in Hospital Corporation of America v. Commissioner, where the court allowed electrical and plumbing systems that served specific equipment to be classified as personal property rather than as part of the building. Rev. Proc. 87-56 places restaurants in Asset Class 57.0, Distributive Trades and Services, which gives much of the equipment and the specialty systems that serve it a 5-year recovery period.
The IRS Cost Segregation Audit Techniques Guide describes six common approaches to assigning cost. A fully engineered and accounted study works under the first two: detailed engineering from actual cost records, or engineering with documented estimates reconciled to actual cost. Each classification is documented with reasoning, photographs, drawings or quantity takeoffs, and a cost tied to a source, and the result is a component schedule your CPA imports and an examiner can trace line by line, signed by credentialed professionals and defended for as long as you own the building. The estimated study applies an industry percentage and gives an examiner nothing to trace.
An office building's electrical and plumbing systems serve the building. A restaurant's electrical, gas, and plumbing systems are sized, routed, and installed to serve the cooking line, the refrigeration, the dish machine, the ice makers, and the beverage dispensers, and under the reasoning the courts have accepted, the portion of those systems that exists to serve equipment can be classified as 5-year property. In a commercial kitchen, that portion is large. Hood and exhaust equipment, fire suppression tied to the cooking line, walk-in coolers and freezers, grease interceptors, water filtration, and carbonation lines are analyzed individually; some qualify as personal property and some stay with the building, and the construction method and function determine the result. Booths, banquettes, the bar, host stands, decorative millwork, accent and pendant lighting, and removable specialty flooring are frequently classified as 5-year property because they are removable or decorative rather than structural. And a freestanding restaurant often sits on a lot where the parking field, drive-thru lane, menu-board pad, patio, dumpster enclosure, landscaping, and exterior lighting represent a meaningful share of total cost, typically 15-year land improvements eligible for bonus depreciation.
Movable furnishings, other equipment without a more specific class, and signage are generally examined as 7-year property. The building structure stays at 39 years: foundation, framing, exterior walls and roof, general-purpose HVAC, plumbing and electrical that serve the building rather than equipment, restrooms, and permanent interior walls. Land is never depreciable, and the land allocation should be supported by the county assessment or an appraisal and consistent across your closing documents, your return, and your study.
Rental real estate is generally a passive activity under Section 469, and passive losses offset only passive income. When Ingrid's real estate LLC generates a $560,000 bonus depreciation deduction, the default result is a large passive loss in the LLC, which cannot offset the active income from the restaurant or her wages. The deduction is suspended and carried forward.
A second rule catches owners by surprise. Under the self-rental rule in Treasury Regulation 1.469-2(f)(6), when you rent property to a business in which you materially participate, net rental income from that property is recharacterized as nonpassive. Net rental losses remain passive unless the business and the building are in the same activity or grouped under Reg. 1.469-4(d)(1)(ii). The rule is deliberately one-directional. Without planning, a restaurant owner ends up with rental income taxed as nonpassive in good years and rental losses trapped as passive in the year the study is taken; our post on why a cost segregation loss gets stuck in a self-rental shows the trap on a real set of numbers.
The planning answer is the grouping election under Treasury Regulation 1.469-4(d)(1)(ii). The regulations generally prohibit grouping a rental activity with a trade or business, but they make an exception when the two activities form an appropriate economic unit and each owner holds the same proportionate interest in both. A restaurant owner who holds the real estate LLC and the operating company in the same proportions can elect to treat the building and the restaurant as a single activity. Once grouped, the depreciation from the study offsets the restaurant's operating income directly.
Three cautions. The election generally must be made on a timely filed return for the year the activities are grouped, with a grouping statement disclosed on the return. Ownership percentages must match; a building held 60/40 and a restaurant held 50/50 do not qualify. And once made, a grouping is generally binding unless there is a material change in facts. This is a decision for your CPA, made before the study is claimed.
A landlord leasing to an unrelated franchisee follows the ordinary rental rules: real estate professional status under Section 469(c)(7) with material participation, or passive income from other sources, determines how quickly the deduction can be used. The at-risk rules, basis limits, and the Section 461(l) cap apply to everyone.
The One Big Beautiful Bill Act, signed July 4, 2025, restored and made permanent a 100 percent rate for qualifying property acquired and placed in service after January 19, 2025, after the phase-down years of 2023 and 2024. The IRS addressed implementation in Notice 2026-11, including how the acquisition date is determined. Property is generally treated as acquired when the taxpayer enters into a written binding contract, and for self-constructed property, when significant physical work begins. If you signed a binding purchase contract on or before January 19, 2025, the property stays at the earlier phase-down rate even if you closed after that date.
Used property qualifies when the taxpayer had no prior use of it and bought it from an unrelated party, so a second-generation space that has housed three concepts before yours can still produce a large first-year deduction. Bonus depreciation is the default unless you elect out for a class of property, which can make sense in a low-income year.
Qualified improvement property. Improvements to the interior of a nonresidential building, placed in service after the building was first placed in service, generally qualify as qualified improvement property with a 15-year recovery period and eligibility for bonus depreciation. Enlargements of the building, elevators and escalators, and the internal structural framework are excluded. For a tenant building out a leased space, much of the interior work beyond the 5-year personal property may still qualify for first-year deduction as 15-year property. Roofs and exterior HVAC do not qualify as qualified improvement property, though they may qualify for Section 179 expensing as qualified real property.
Who owns the improvements. When a landlord funds a tenant improvement allowance, the tax treatment depends on who is treated as owning the improvements. Get this right at lease signing, because it determines whose return the depreciation lands on; see how landlords deduct a tenant buildout.
Repairs, improvements, and partial dispositions. Under the tangible property regulations, some remodel costs are deductible repairs and others must be capitalized. And when you tear out a bar, replace the flooring, or re-pave the lot, you may be able to claim a partial asset disposition under Reg. 1.168(i)-8 for the undepreciated basis of what you removed, instead of continuing to depreciate something that no longer exists.
Restaurant equipment is where Section 179 expensing and bonus depreciation overlap. The One Big Beautiful Bill Act raised the Section 179 limit to $2.5 million, indexed for inflation, with the phase-out beginning at $4 million of qualifying purchases. Section 179 cannot create or increase a loss, which makes it most useful for a profitable operating company buying ovens, fryers, refrigeration, and point-of-sale hardware, and it reaches roofs, HVAC, fire protection, and security systems on nonresidential buildings, which bonus depreciation does not. Bonus depreciation has no dollar limit and can create a loss. Many restaurant owners use both, with the CPA deciding asset by asset from the study's asset-level detail.
The ideal time to commission a study is for the year you place the restaurant in service. The study has to be finished before you file that return, and December 31 has nothing to do with it. If you bought, built, or renovated a restaurant in a prior year and never did a study, the opportunity is still there. A look-back study identifies the missed depreciation, and the catch-up is taken as a Section 481(a) adjustment in a single year through a change in accounting method on Form 3115, without amending prior returns. Cost Seg America prepares the Section 481(a) computation and, for a separate fee, the Form 3115 itself; your CPA files it with the return. For a restaurant you have owned for several years, the look-back is often where the largest catch-up sits.
Depreciation reduces your tax basis, and when you sell, some of the benefit is recaptured. Gain attributable to depreciation on personal property components (Section 1245 property) is taxed as ordinary income up to the amount of depreciation taken. Depreciation on the building is taxed as unrecaptured Section 1250 gain, capped at 25 percent for individuals. The tax code reduces your basis for depreciation you were allowed whether or not you claimed it, so you face recapture either way. The value of the study is the time value of the tax savings and the ability to use that cash while you hold the asset, which for a restaurant owner often means funding the next location. A Section 1031 exchange can defer recapture into a replacement property, and holding until death gives heirs a step-up in basis. Your CPA should model the exit before you decide, and our guide to what you actually pay back in recapture shows the arithmetic.
Buying the estimated study. A report that applies an industry percentage and calls it a study gives an examiner nothing to trace. An engineered study documents each component, how it is installed, what it serves, and how its cost was determined.
Skipping or forfeiting the grouping election. Owner-operators who hold the building separately and never group the activities can watch a large deduction become a suspended passive loss while their restaurant pays full tax on its income. Bringing in a partner on the real estate but not the operating company forfeits the election, so structure both entities with it in mind.
Ignoring the land allocation. A land value that is too high shrinks the depreciable basis, and one that is too low without support invites questions.
Missing the acquisition date rules. If your contract straddles January 19, 2025, the bonus rate may not be 100 percent. Confirm the contract date before anyone quotes a savings number.
Treating the remodel as one asset. A $400,000 franchisor-mandated remodel contains 5-year property, 15-year qualified improvement property, repairs, and partial dispositions. Capitalizing it as a lump into the building leaves most of that value on the table.
If the depreciable basis after land is under $180,000, the fee eats the benefit. If you expect to sell the building within a couple of years with no exchange planned, Section 1245 recapture at ordinary rates can outweigh the time value of the deduction. If you lease to an unrelated operator, are not a real estate professional, and have no passive income, the loss will sit suspended until you have passive income or sell, and the cash benefit arrives late. And if the building and the restaurant are held in mismatched percentages and nobody will fix that, the grouping election is off the table and the owner-operator advantage goes with it.
It varies with the concept, the construction, and how much of the property is land. Freestanding restaurants with drive-thrus and large parking fields often see a greater share than an in-line space in a strip center. Be skeptical of any provider who quotes a percentage before analyzing your property.
Often yes, if your CPA makes a grouping election under Treasury Regulation 1.469-4(d)(1)(ii) treating the rental and the restaurant as one activity. The election requires matching ownership percentages in both entities and is made on a timely filed return. Without it, rental losses remain passive even though rental income from self-rented property is treated as nonpassive.
Much of it does. Interior improvements to a nonresidential building typically qualify as qualified improvement property with a 15-year life and bonus eligibility, and the components that serve equipment or are decorative may be 5-year property. Replaced components may also support a partial disposition deduction.
In most cases, yes. A look-back study with a Section 481(a) adjustment lets you catch up in the current tax year without amending prior returns. Cost Seg America prepares the computation and, for a separate fee, the Form 3115 itself; your CPA files it.
It depends on your taxable income and whether you want to create a loss. Section 179 is capped and cannot create a loss; bonus depreciation is uncapped and can. Many owners use both, and a study gives your CPA the asset-level detail needed to choose.
No one can promise what the IRS selects for examination. A study is a recognized method the IRS describes in its own audit guide, and the risk is tied to the quality of the study and its support. Our team's work has been through 125+ IRS examinations with zero losses and $0 returned, and audit defense is included for as long as you own the building, with no time limit, no hour cap, and no additional fee, through written responses and participation in examiner calls alongside your CPA.
If you own, are buying, or are building a restaurant, the right time to ask is before you file the return for the year you placed it in service, and for older properties, now. Send Jim Dougherty and his team at Cost Seg America the closing statement, the contract date, a few photos of the kitchen, dining room, and site, any remodel invoices, and a note on how you hold the real estate and the operating company. You will have a free proposal within 24 hours showing the likely reclassification and the first-year number, and we will raise the grouping question with your CPA before anything is ordered. Call 1-888-365-5023 or email info@costsegamerica.com.
This article is for general educational purposes and does not constitute tax, legal, or accounting advice; the examples are illustrative, and your results depend on your property, your facts, and current law, so consult your CPA before making any tax decision.
Use the calculator, see your number, and request your free, no-cost proposal - delivered in 24 hours, with your flat fee quoted upfront and no obligation.