Cost segregation is a tax strategy that allows property owners to accelerate depreciation deductions, reducing taxable income and increasing cash flow. It applies differently to commercial and residential properties due to variations in depreciation timelines.

How Cost Segregation Works

When a building is purchased, constructed, or renovated, the IRS generally classifies it as real property, which is depreciated over:

  • 39 years for commercial properties.
  • 27.5 years for residential rental properties.

However, Cost segregation identifies components of the building that can be classified as personal property (such as lighting, flooring, HVAC systems, and land improvements), which can be depreciated over 5, 7, or 15 years instead.

Effects on Commercial Properties

  • Larger tax savings: Since commercial buildings have a longer depreciation period (39 years), reclassifying components to shorter lifespans accelerates deductions.
  • Increased cash flow: By front-loading depreciation, owners have more funds available for reinvestment.
  • Beneficial for renovations: Cost segregation can be applied retroactively to past improvements.

Effects on Residential Properties

  • Still beneficial but slightly less impact: Residential properties already have a shorter depreciation period (27.5 years), so the acceleration isn’t as pronounced as in commercial real estate.
  • Ideal for multifamily properties: Apartment buildings and other residential rentals can benefit significantly from cost segregation.
  • Bonus depreciation available: The Tax Cuts and Jobs Act (TCJA) allows 100% bonus depreciation on assets with a life of 20 years or less, further enhancing benefits.

Key Considerations

  • Engineering study required: A detailed cost segregation study by tax professionals or engineers is necessary to ensure compliance with IRS rules.
  • Recapture tax risk: If the property is sold, depreciation deductions may be subject to recapture at a higher tax rate.
  • Best for high-cost properties: Cost segregation provides more value for expensive properties with substantial personal property components.

Would you like insights on whether cost segregation is a good strategy for a specific property type?