Electrical Distribution: How the ATG Allocates Building Power

A building's electrical system does not necessarily belong entirely to the building for depreciation purposes. The 2025 IRS Cost Segregation Audit Technique Guide describes a functional allocation approach that can divide a building's primary and secondary electrical distribution system between § 1245 property serving qualifying equipment and § 1250 property serving general building functions. The key is not simply where electricity flows, but what the electrical system was designed to power. For CostSegRx engineers, that means tracing end-use equipment and analyzing electrical demand load rather than applying an arbitrary percentage to the electrical contract.

Wondering how much tax you could save with cost segregation? Let’s find out. Schedule a Cost Segregation Strategy Call today.

Key Takeaways

• The ATG's functional allocation approach can divide primary and secondary electrical distribution between § 1245 equipment-related property and § 1250 building-related property.
• The allocation follows the electrical demand load of end-use equipment rather than simply assigning costs to individual circuits.
• Connected load and demand load are different concepts, and an energy-use study measured in kilowatt-hours should not replace the demand-load analysis used for functional allocation.
• Engineers trace end-use equipment, identify dedicated circuits and hook-ups, determine demand factors, and separate equipment loads from general building loads.
• The ATG's electrical guidance developed from case law including Scott Paper, Morrison, HCA, and other cases, while recognizing competing approaches such as A.C. Monk.
• A building can have one shared electrical distribution system while the demand load supports a measurable allocation between § 1245 and § 1250 property.
• A defensible electrical allocation is supported by engineering load analysis, not a convenient percentage selected without reference to the building's actual electrical design.

What Is Functional Allocation of an Electrical Distribution System?

The electrical distribution system, or EDS, includes the infrastructure that distributes electrical power throughout a building.

The ATG's issue-specific electrical guidance addresses the proper allocation of the overall EDS between § 1245 property and § 1250 property. It describes a functional allocation approach that has developed through decades of court decisions.

The basic concept is straightforward.

Some electricity is used for the operation or maintenance of the building.

That includes functions such as lighting, heating, ventilation, air conditioning, and general-use electrical outlets.

Other electricity is used to operate qualifying machinery or equipment that is an integral part of the taxpayer's business.

The ATG treats the first category as building-related § 1250 property.

The second can support § 1245 treatment.

This means one electrical distribution system can contain characteristics of both property classes.

The ATG's discussion of Hospital Corporation of America explains that the portion of primary and secondary electrical distribution corresponding to the electrical load carried to qualifying equipment can be treated as § 1245 property, while the portion corresponding to building operations can be treated as § 1250 property.

That is the foundation of functional allocation.

It is also why an electrical system cannot always be classified as one asset simply because the components are physically interconnected.

How Does the ATG Measure the Allocation?

The ATG focuses on the electrical demand load of the end-use equipment.

This is important because the electrical system is designed around the amount of power the building and its equipment are expected to require.

The ATG defines connected load as the actual power required by a specific circuit to safely operate the attached end-use equipment.

Demand load is different.

It is the factored load used in designing the overall electrical system. Demand factors are applied to portions of the electrical system and are an important part of determining the size and cost of electrical infrastructure.

The total demand load helps determine the size and type of the electrical service required for the facility.

It also affects the sizing of conductors, circuit breakers, transformers, switchgear, capacitors, conduit, and other electrical equipment.

That makes demand load particularly relevant to the functional allocation analysis.

The ATG states that the functional allocation approach uses electrical loads rather than the costs of individual specified circuits to determine the portion of the primary and secondary EDS allocable to § 1245 property.

The cost comes later.

First determine the functional allocation.

Then apply that allocation to the appropriate electrical distribution costs.

Why Can't You Use Energy Consumption Instead?

Because energy consumption and electrical design load answer different questions.

An energy-use study measures how much electricity was actually consumed during a period, commonly in kilowatt-hours.

A demand-load analysis addresses the electrical capacity required to safely design and size the building's electrical system.

The ATG expressly states that an energy efficiency study measured in kilowatt-hours is completely different from the demand-load analysis used when designing and sizing building electrical equipment. It should not be used as part of the functional allocation approach.

Consider a production machine that operates intermittently.

Its annual energy consumption may be relatively low.

But the electrical infrastructure still has to be sized to safely support the machine when it operates.

The demand load therefore can be much more relevant to the design of transformers, feeders, switchgear, conductors, and other shared electrical infrastructure.

This distinction is also why electrical distribution systems in cost segregation require engineering analysis rather than simply pulling historical utility data.

The question is not:

“How many kilowatt-hours did this equipment consume?”

The question is:

“What electrical demand was the system designed to accommodate?”

How Do Engineers Perform the Allocation?

The analysis starts with the building's electrical design.

CostSegRx engineers can review electrical plans, load schedules, panel schedules, one-line diagrams, equipment schedules, specifications, contractor documentation, and field conditions.

Then identify the end-use loads.

Which equipment qualifies as § 1245 property?

Which electrical loads serve general building functions?

Which loads serve both?

The ATG's supermarket illustration shows how this can work.

HVAC can contain both building-related and equipment-related loads.

Kitchen exhaust fans can be separated from the general HVAC load.

Refrigerator and freezer compressors can qualify as equipment loads.

General office outlets can remain building-related.

Some departments can contain both dedicated equipment loads and general-use outlets, requiring the load to be split.

Demand factors are then applied to the connected loads to calculate demand watts.

The resulting demand load for qualifying § 1245 equipment is compared with the building's total demand load.

That produces the functional allocation percentage.

The branch circuits and equipment hook-ups require their own analysis.

The ATG states that costs associated with branch circuits and hook-ups serving dedicated machinery and equipment follow the recovery period of the equipment they serve, while branch circuits and hook-ups serving building-related items such as HVAC, general-use outlets, lighting, and other building services follow the building's recovery period.

This is where engineering documentation becomes particularly important.

A quality cost segregation study should be able to explain how the electrical allocation was developed and how the costs reconcile to the actual electrical installation.

What Case Law Supports Functional Allocation?

The ATG's electrical guidance did not originate from one administrative formula.

It developed through case law.

In Scott Paper Co. v. Commissioner, the Tax Court focused on the ultimate uses of electrical power and distinguished power used for building operation and maintenance from power used to operate machinery.

The court allocated the facility's primary electrical system between those uses based on the power demand or design load of the machinery and equipment.

That became known as the functional allocation approach.

In Morrison, Inc. v. Commissioner, the Tax Court followed the approach from Scott Paper and held that electrical distribution systems were not structural components to the extent of the load percentages carried to qualifying equipment. The Eleventh Circuit affirmed. The ATG notes that the IRS subsequently stated it would not challenge the functional allocation approach described in Scott Paper.

Hospital Corporation of America also applied allocation concepts to primary and secondary electrical distribution.

But the legal history is not completely uniform.

The Fourth Circuit rejected the functional allocation approach in A.C. Monk & Co. v. United States and instead considered whether the electrical system could reasonably be adapted to more general uses. The ATG also discusses other approaches in its legal background.

That history matters because the ATG is not presenting functional allocation as a casual rule of thumb.

It is presenting a specific engineering and legal methodology that developed through litigation and IRS guidance.

For practitioners, the takeaway is simple:

Use the methodology actually described in the ATG.

Document the engineering inputs.

Do not replace the analysis with a convenient assumption.

How Does Functional Allocation Work in Practice?

Illustrative example only. Figures shown are estimated for demonstrative purposes only. Actual classifications, costs, asset classes, recovery periods, depreciation deductions, and tax results depend on the specific property, business activity, supporting documentation, engineering analysis, and taxpayer circumstances.

Assume a large commercial facility has $1,000,000 of primary and secondary electrical distribution costs.

The system serves both general building functions and qualifying equipment.

After reviewing the electrical plans and end-use equipment, the engineering analysis identifies the demand loads associated with § 1245 equipment and separates them from § 1250 building loads.

Assume the resulting § 1245 demand load represents 38.4% of the total demand load.

The ATG's supermarket example uses this same percentage for illustration.

Applying 38.4% to the $1,000,000 of primary and secondary EDS costs produces:

$1,000,000 × 38.4% = $384,000

The remaining 61.6%, or $616,000, is allocated to § 1250 property.

The important point is not the 38.4% itself.

It is how the percentage was developed.

It came from the demand load analysis.

The ATG's example then combines the functional allocation of the primary and secondary EDS with the separately analyzed branch circuits and equipment hook-ups to reach the overall electrical allocation.

This is very different from saying:

“Thirty percent of the electrical system seems equipment-related.”

A defensible allocation has an engineering basis.

What Is the Most Important Electrical Allocation Question?

Do not begin with:

What percentage of this electrical system should be short-life property?

Instead ask:

What was the electrical distribution system designed to power?

Then trace the answer.

Identify the end-use equipment.

Determine the connected load.

Apply the appropriate demand factors.

Separate qualifying § 1245 equipment loads from general building loads.

Calculate the resulting demand-load allocation.

Apply that allocation to the appropriate primary and secondary EDS costs.

Then separately identify branch circuits and equipment hook-ups that directly serve qualifying equipment.

The ATG describes this as a complex and labor-intensive process. It requires determining the costs of the relevant portions of the EDS, analyzing the building's overall electrical demand load, and allocating the primary and secondary EDS appropriately.

For CostSegRx engineers, that distinction is critical.

The electrical system is designed around power requirements.

The cost segregation analysis should follow that engineering reality.

Do not assign a percentage of a building's electrical system to short-life equipment because the percentage “looks reasonable.” Engineers trace the electrical system and use the design demand load of the end-use equipment to support the functional allocation.