Cost Segregation: Accelerating Depreciation on Major Properties

Cost segregation studies can front-load depreciation deductions by breaking down properties into 5, 7, and 15-year components for rapid tax savings.

How it works. A standard residential rental depreciates over 27.5 years and commercial property over 39 years. A cost segregation study identifies building components -- electrical systems, flooring, cabinetry, paving, landscaping -- that qualify for shorter recovery periods of 5, 7, or 15 years under MACRS. This front-loads deductions into the early years of ownership.

Bonus depreciation amplifies the benefit. Components reclassified to 5, 7, or 15-year lives can qualify for bonus depreciation under Section 168(k), allowing you to deduct a large percentage of their cost in year one. On a $2 million acquisition, a cost segregation study might identify $400,000-$600,000 in components eligible for immediate deduction.

Lookback studies for existing properties. If you purchased a property years ago without a cost segregation study, you can still benefit. A lookback study reclassifies components retroactively, and the accumulated missed depreciation is claimed in a single year through a Section 481(a) adjustment -- no amended returns required.

The tradeoff: Cost segregation accelerates deductions but doesn't create new ones. You're borrowing from future depreciation, which reduces your tax basis and increases depreciation recapture when you sell.