What Is a Cost Segregation Study?
Under standard tax rules, real estate is depreciated over long schedules—27.5 years for residential rental property and 39 years for commercial property. However, a property is more than just its core structure. Elements such as carpeting, plumbing fixtures, electrical systems, parking lots, and landscaping are all part of the purchase but typically have much shorter useful lives when evaluated under IRS-compliant methodologies.
Individually, many of these components would be depreciated over 5, 7, or 15 years instead of 27.5 or 39. A cost segregation study breaks down these components and reallocates the purchase price into shorter-lived categories. This enables real estate owners to accelerate depreciation and maximize deductions.
Why Cost Segregation Matters for Real Estate Owners
The primary advantage of cost segregation lies in the time value of money. By front-loading depreciation deductions into the early years of ownership, real estate owners reduce taxable income and retain more capital for reinvestment or daily operations.
Although a cost segregation study involves an upfront fee, the long-term tax savings often far exceed the cost. For short-term property holders, however, the benefits may be limited due to potential depreciation recapture upon sale. Long-term real estate investors typically see the greatest advantage.
Who Conducts a Cost Segregation Study?
Cost segregation studies are not DIY projects. They require specialized expertise from a team of engineers and tax professionals who analyze the property’s construction details, cost records, architectural drawings, and, often, perform an onsite inspection.
This multidisciplinary team ensures compliance with IRS methodologies while identifying which property components qualify for shorter depreciation schedules.
How the Process Works
The objective of a cost segregation study is to identify all eligible portions of a property that can be depreciated over 5, 7, or 15 years—or fully expensed using bonus depreciation (60% in 2024, rising to 100% in 2025).
A typical process includes:
- Reviewing blueprints, construction costs, or purchase agreements
- Conducting a physical inspection (in most cases)
- Allocating asset costs into the correct tax categories
- Delivering a detailed report for tax return preparation
Example: The Impact of a Cost Segregation Study
Imagine purchasing an office building for $10,000,000, with $2,000,000 allocated to land (non-depreciable) and $8,000,000 to the building.
- Without cost segregation: The $8,000,000 building is depreciated over 39 years, producing about $205,128 in annual deductions. At a 37% tax rate, that saves $75,900 annually.
- With a cost segregation study:
- $1,000,000 reclassified as 5-year property (interior finishes)
- $1,000,000 as 7-year property (fixtures)
- $1,000,000 as 15-year property (landscaping/parking)
If bonus depreciation applies (100% in 2025), you could deduct the $3,000,000 immediately, plus depreciation on the remaining property. That results in over $1.1M in first-year tax savings—a significant improvement.
Even without bonus depreciation, the accelerated deductions increase first-year savings by nearly $117,000 compared to the standard method.
When Should Real Estate Owners Conduct a Cost Segregation Study?
The best time to perform a cost segregation study is in the year a property is acquired, built, or renovated. However, real estate owners can also benefit from a look-back study on older properties. In such cases, filing IRS Form 3115 allows for a “catch-up” adjustment without amending prior-year returns.
This retroactive approach makes cost segregation a valuable strategy even for properties placed in service years ago.
Final Thoughts
Cost segregation studies are a powerful tax strategy for real estate owners seeking to maximize deductions, improve cash flow, and reinvest savings back into their portfolios. Whether you are purchasing a new property, expanding your holdings, or evaluating existing assets, a study can uncover substantial opportunities.
At Singh & Associates LLP, we specialize in helping real estate investors in Los Angeles and beyond take advantage of tax strategies like cost segregation. Contact our team today to learn more or to schedule a consultation about whether a cost segregation study could benefit your real estate investments.
