Tax Strategy

Cost Segregation: Accelerate Depreciation, Maximize Deductions

Front-Load Your Real Estate Tax Benefits

Cost segregation reclassifies building components for faster depreciation. Learn how bonus depreciation and look-back studies generate massive first-year tax savings.

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20-40%

Typical Building Cost Reclassified

60%

Bonus Depreciation Rate (2024)

5-10x

Typical ROI on Cost Seg Study

Year 1

When You Capture Maximum Benefits

Quick Answer

Cost segregation reclassifies building components from 39-year to 5/7/15-year depreciation - front-loading deductions
Bonus depreciation (60% in 2024) applies to reclassified components, generating massive first-year deductions
Look-back studies capture missed depreciation on existing properties without amending prior returns
Typical properties see 20-40% of building cost reclassified to shorter-life property
ROI on cost segregation studies typically exceeds 5-10x the study cost in first-year tax savings

The Opportunity

Why Cost Segregation Matters

Accelerate Depreciation from 39 Years to 5-15 Years

Cost segregation reclassifies building components from 39-year real property to 5, 7, or 15-year personal property. Electrical systems, plumbing, carpeting, cabinetry, parking lots, and landscaping can all be depreciated faster. The result: front-loaded deductions that reduce taxes immediately.

Bonus Depreciation Multiplier Effect

Components classified as 5, 7, or 15-year property qualify for bonus depreciation (60% in 2024, phasing down 20% per year). On a $2M building with $600K of shorter-life property, first-year bonus depreciation alone can generate $360K+ in deductions - versus $13K with straight-line depreciation.

Time Value of Tax Savings

A dollar saved today is worth more than a dollar saved in 20 years. By accelerating deductions to year one, you get the time value of money working in your favor. Reinvest tax savings now for compound growth rather than waiting decades for depreciation benefits.

Works with Existing Properties (Look-Back Studies)

Missed cost segregation when you purchased? No problem. A look-back study can capture all missed depreciation in a single year through a catch-up deduction (IRS Revenue Procedure 2022-14), without amending prior returns. This applies to any property placed in service in prior years.

Implementation

Proven Strategies

New Acquisition Cost Segregation

Perform cost segregation study immediately upon acquisition. The engineering analysis identifies all building components eligible for accelerated depreciation. Maximize bonus depreciation by placing the property in service before year-end. The study typically takes 2-4 weeks and pays for itself many times over.

Best for: Any investor acquiring commercial property over $750K where immediate tax deductions are valuable.

Example:

Purchase $3M commercial building (assume $2.4M depreciable after land). Standard depreciation: $61K/year. Cost seg identifies $720K (30%) as 5/7/15-year property. With 60% bonus depreciation: $432K first-year deduction. At 37% bracket: $160K tax savings year one.

Look-Back Study for Existing Properties

For properties already owned, a look-back study calculates all depreciation that should have been taken under cost segregation. File Form 3115 (Change in Accounting Method) to claim the entire catch-up deduction in the current year - no amended returns needed. Works for properties acquired years ago.

Best for: Investors with existing properties who never performed cost segregation and want to capture missed deductions.

Example:

Own $2M property for 5 years, using straight-line depreciation. Cost seg study shows $500K should have been shorter-life property. Cumulative missed depreciation: $200K. Claim full $200K catch-up deduction this year via Form 3115. At 37%: $74K immediate tax savings.

Renovation and Improvement Cost Segregation

Major renovations and tenant improvements also qualify for cost segregation. A partial asset disposition election allows you to write off the remaining basis of replaced components while depreciating new improvements on accelerated schedules. Particularly valuable for value-add investors.

Best for: Value-add investors performing significant renovations or tenant improvements.

Example:

$500K renovation of commercial property. Standard: depreciate over 39 years ($12.8K/year). Cost seg: 40% ($200K) classified as 5-year property. With bonus depreciation: $120K first-year deduction vs $12.8K. Partial disposition writes off remaining basis of replaced items.

Avoid These Pitfalls

Common Mistakes

Waiting Too Long to Perform the Study

Cost segregation is most valuable in year one when bonus depreciation applies. Waiting years to perform the study means missing maximum bonus depreciation benefits. Even with look-back studies available, earlier is better for cash flow optimization.

Using Non-Engineering Based Studies

The IRS prefers engineering-based cost segregation studies with detailed component analysis. Desktop studies or estimates without site visits may not withstand audit scrutiny. Invest in a proper engineering study from a qualified firm - the incremental cost is minimal relative to benefits.

Ignoring Real Estate Professional Status Requirements

Cost segregation creates paper losses that are passive losses for most taxpayers. Unless you qualify as a Real Estate Professional, these losses may be suspended and carried forward rather than used immediately. Plan cost segregation alongside your passive activity status.

Questions

Common Questions

Here are the most common questions we receive about this topic.

Ask Your Question

Most commercial and residential rental properties benefit, especially: apartment buildings, office buildings, retail centers, industrial facilities, medical offices, hotels, restaurants, and self-storage. Generally cost-effective for buildings over $750K-$1M in value. Short-term rentals and properties with significant tenant improvements benefit greatly.

Typically $5,000-$15,000 for small to mid-size properties, $15,000-$30,000 for larger or more complex properties. The cost depends on property type, size, and complexity. ROI is usually 5-10x+ the study cost in first-year tax savings. Consider it an investment that pays for itself immediately.

Bonus depreciation allows immediate deduction of a percentage of qualified property cost in year one. For 2024, the rate is 60% (was 100% in 2022, phasing down 20% per year). Property must be classified as 5, 7, or 15-year to qualify. Cost segregation is required to reclassify building components into these categories.

Yes, accelerated depreciation creates recapture exposure when you sell. Section 1250 recapture (25% rate) applies to real property depreciation in excess of straight-line; Section 1245 recapture (ordinary rates) applies to personal property. However, 1031 exchange defers all recapture. The time value of current savings usually outweighs future recapture.

Yes. A look-back study calculates all accelerated depreciation that should have been taken. File Form 3115 (automatic approval) to claim the cumulative catch-up deduction in the current year. No amended returns needed. This applies to any property regardless of when acquired.

Ready to Maximize Your Depreciation?

Cost segregation delivers immediate tax savings that compound over time. Let us connect you with qualified engineers and ensure your study maximizes benefits.

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