Cost Segregation: A Powerful Tax Planning Strategy for Business Owners
Cost segregation is a powerful tax planning strategy for business owners who own real estate. It allows you to accelerate depreciation deductions by identifying and reclassifying certain building components and improvements from a standard 39-year (commercial) or 27.5-year (residential) depreciation schedule to shorter lives of 5, 7, or 15 years.
Why It Matters for Business Owners
Cost segregation can:
- Increase cash flow by reducing current tax liability.
- Accelerate depreciation deductions, often producing large upfront tax savings.
- Enable tax deferral, allowing reinvestment of those tax savings into the business.
How It Works
A cost segregation study is typically conducted by engineers and tax professionals who:
- Analyze the property’s construction or acquisition cost.
- Break down the building into personal property (like equipment, flooring, lighting) and land improvements (like parking lots, landscaping).
- Reclassify these assets into shorter-life categories for depreciation purposes.
Example
Suppose you purchase a commercial building for $1 million:
- Without cost segregation: Entire building depreciated over 39 years = ~$25,600/year.
- With cost segregation: Let’s say $300,000 is reclassified into 5-, 7-, or 15-year assets. You might deduct $60,000+ in the first year alone.
Bonus Depreciation Opportunity
Thanks to the Tax Cuts and Jobs Act (TCJA), bonus depreciation allowed a 100% immediate write-off for qualifying assets through 2022.
- Phased down to 80% in 2023
- Phased down to 60% in 2024
- Timing of the cost segregation study matters.
Best Candidates for Cost Segregation
- Owners of newly constructed buildings
- Buyers of existing buildings
- Those renovating or expanding real estate
- Leaseholders who make tenant improvements
Key Considerations
- Cost: A study can range from a few thousand dollars to over $10,000 depending on the complexity and size.
- IRS Compliance: The study must follow IRS-approved methods and documentation.
- Recapture Risk: If you sell the property, you may have to “recapture” the accelerated depreciation, though this can often be planned for.
Take the Next Step
Would you like help finding a reputable provider for a cost segregation study or exploring if it’s a fit for your specific property?
