How to Save $100K on Taxes with Cost Segregation

What if one real estate tax strategy could potentially reduce your tax bill by $100,000 or more?

For some real estate investors, that isn't an exaggeration.

Cost segregation can dramatically accelerate the depreciation deductions associated with a rental or investment property. When those deductions are combined with favorable depreciation rules and the right tax situation, the resulting tax savings can be substantial.

Here's how the math can work.

The Example: A $1.5 Million Rental Property

Assume you purchase an investment property for $1,500,000.

The first step is separating the value of the land, because land isn't depreciable. For this example, assume:

Purchase price: $1,500,000Land value: $300,000Depreciable basis: $1,200,000

Without a cost segregation study, most of that $1.2 million building basis would generally be depreciated over 27.5 years for residential rental property or 39 years for nonresidential real property.

That means the tax deduction is spread over decades.

A cost segregation study changes the timing.

What Cost Segregation Does

Instead of treating nearly everything as part of the building, a cost segregation study identifies components that may qualify for shorter depreciation periods.

Depending on the property, this can include items such as:

• Appliances, certain cabinetry, carpeting, and other personal property

• Certain electrical and plumbing components serving qualifying equipment

• Fencing, landscaping, parking areas, sidewalks, and other land improvements

• Other qualifying 5-, 7-, and 15-year property

These assets can be depreciated much faster than the building itself.

And that's where the potential tax savings become interesting.

Turning $1.2 Million Into a Much Larger Upfront Deduction

Suppose the cost segregation study identifies 30% of the depreciable basis as shorter-life property.

That's: $1,200,000 × 30% = $360,000

Instead of depreciating that $360,000 over 27.5 or 39 years, some or all of those qualifying assets may be eligible for accelerated depreciation, including bonus depreciation to the extent permitted under current tax law.

The result could be hundreds of thousands of dollars of additional depreciation deductions in the early years of ownership.

How That Can Become $100,000 of Tax Savings

Assume the cost segregation study produces approximately $300,000 of additional first-year depreciation compared with conventional depreciation.

If those deductions are currently usable and the investor's combined marginal federal and state income tax rate is approximately 35%, the potential tax reduction is:

$300,000 × 35% = $105,000

That's more than $100,000 in potential tax savings from accelerating deductions that otherwise could have taken decades to receive.

Importantly, cost segregation generally doesn't create depreciation out of thin air. It primarily changes when you receive the deductions.

And receiving a deduction today can be considerably more valuable than receiving the same deduction 10, 20, or 30 years from now.

There's One Big Catch: Can You Actually Use the Loss?

This is one of the most important parts of cost segregation planning.

Generating a $300,000 depreciation deduction doesn't automatically mean you'll reduce this year's taxes by $100,000.

Rental real estate losses are generally subject to the passive activity loss rules. Whether you can use the deduction currently depends on your individual circumstances.

For example, the result can be very different for someone who qualifies as a real estate professional and materially participates compared with an investor whose rental losses remain passive.

Short-term rentals can also present different planning opportunities depending on the average rental period and the owner's level of participation.

Unused passive losses generally aren't simply lost. They may be suspended and carried forward until they can be used under the applicable tax rules.

That's why cost segregation should be viewed as part of an overall tax strategy—not simply as a way to generate the largest possible depreciation number.

What If You Already Own the Property?

You may still be able to benefit.

Cost segregation isn't limited to properties purchased this year.

In many situations, an investor who has owned and depreciated a property for several years can complete a cost segregation study and use a change in accounting method to claim previously missed depreciation.

This is commonly accomplished through a Section 481(a) adjustment, generally reported with Form 3115.

Instead of amending several prior-year tax returns, the taxpayer may be able to recognize the cumulative depreciation adjustment in the current year.

For the right property, that catch-up deduction can be significant.

What Types of Properties Can Benefit?

Cost segregation isn't just for massive apartment complexes and commercial buildings.

It can potentially benefit owners of:

Short-term rentals and Airbnbs

Long-term residential rentals

Multifamily properties

Office buildings

Retail properties

Restaurants

Medical and dental offices

Warehouses and industrial properties

Self-storage facilities

Hotels and hospitality properties

Even relatively modest rental properties can have meaningful amounts of 5-, 7-, and 15-year property.

The question is whether the accelerated tax benefits justify the cost of the study.

The Bottom Line

If you own investment real estate, don't automatically assume the entire building should be depreciated slowly over 27.5 or 39 years.

A properly prepared cost segregation study may identify substantial portions of the property that qualify for accelerated depreciation.

For the right investor, the numbers can look something like this:

$1.5 million property

$1.2 million depreciable basis

$300,000+ of additional accelerated depreciation

35% assumed combined tax rate

Potential near-term tax savings: $100,000+

Your actual savings will depend on the property, depreciable basis, placed-in-service date, applicable depreciation rules, tax rates, passive activity limitations, and your ability to use the deductions.

But the basic principle is simple:

The sooner you receive a tax deduction, the sooner you can put those dollars back to work.

Find Out What Your Property Could Save

At 24 Hour Cost Seg, we specialize in making cost segregation fast, straightforward, and affordable for real estate investors.

Our residential cost segregation studies for qualifying properties under $2 million are just $499, with a 24-hour turnaround.

Instead of wondering whether your property is leaving tax deductions on the table, find out.

Get your cost segregation study at 24 Hour Cost Seg today.

This article is for general informational purposes only and does not constitute tax, legal, or accounting advice. Tax results vary based on individual circumstances. Consult your tax advisor regarding the application of these rules to your specific situation.