The Cost Segregation Study a 58-Year-Old Landlord Just Used to Deduct $186,000 of Rental Depreciation in the First Year
For many real estate investors, one of the biggest tax advantages of owning a rental property is depreciation. Depreciation is a valuable strategy that lets investors gradually recover the cost of a property’s building and improvements over its usable…
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For many real estate investors, one of the biggest tax advantages of owning a rental property is depreciation. Depreciation is a valuable strategy that lets investors gradually recover the cost of a property’s building and improvements over its usable life — operative word being “gradually.”
But some investors may want to reap that tax break sooner. And if so, there’s one strategy that could do the trick.
How a cost segregation study could result in near-term tax savings
Recently, Mike, a 58-year-old landlord with a high income, used a cost segregation study to reduce his tax bill substantially. The strategy allowed him to deduct $186,000 of depreciation his first year of ownership rather than spread out that deduction over time.
See, rental property owners generally can’t deduct the full purchase price of a property immediately. Instead, the IRS requires investors to depreciate residential rental buildings over 27.5 years and commercial properties over 39 years.
For example, if you buy a residential building with $550,000 allocated to the structure itself, excluding land, you’d normally take an annual depreciation deduction of $20,000 over 27.5 years. A cost segregation study could help accelerate that timeline.
A cost segregation study breaks down a property into different components and can reclassify certain parts of a building into shorter depreciation schedules.
In other words, instead of treating every component equally and subjecting it to a 27.5- or 39-year depreciation schedule, certain items can qualify for a shorter timeline. Features like appliances, lighting, flooring, and fencing may qualify for depreciation schedules as short as five, seven, or 15 years instead of 27.5 or 39 years.
Sweetening the deal is that the One Big Beautiful Bill Act reinstituted the 100% bonus depreciation for eligible assets. Combined with cost segregation, the two tax breaks could make it possible for real estate investors to supercharge their savings.
When the strategy makes sense
The approach Mike used is generally viable for landlords with significant taxable income who can immediately benefit from larger deductions.
A cost segregation study isn’t free. You might pay anywhere from $3,000 to $15,000 to have one done. So you’ll need to make sure the tax savings justify that outlay.
Your tax bracket also directly impacts how much value you get out of this strategy. A higher bracket increases the savings from any depreciation you can accelerate through a cost segregation study.
For example, if you have a 37% marginal tax rate, every $10,000 of accelerated depreciation you qualify for can save you $3,700 in taxes. If you have a marginal tax rate of 24%, you’re getting $2,400 in savings per $10,000 of accelerated depreciation.
This isn’t unique to real estate investors or this particular tax break. It’s basically how tax deductions work across the board — the higher your tax rate, the more value they offer.
If you’re looking to do a cost segregation study, the best time is typically the year you acquire or renovate a property. But you can have one of these studies done at any time and potentially claim the resulting write-offs.
It’s also important to understand that accelerating depreciation today may reduce deductions available later. It may also increase depreciation recapture taxes when the property is sold.
For these reasons, you may want to consult a tax professional before utilizing this strategy. But it could be a smart thing to look into if you’re in a high tax bracket and want to enjoy more near-term tax savings.
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Maurie Backman has more than a decade of experience writing about financial topics, including retirement, investing, Social Security, and real estate. Her work has appeared on sites that include The Motley Fool, USA Today, U.S. News & World Report, and Kiplinger.
Prior to becoming a full-time financial writer, Maurie worked in the financial industry trading distressed debt. She then changed course and spent a few years designing electronic toys. After a stint in content marketing and UX, she shifted back into writing and has since covered everything from the housing market to estate planning to Medicare.
When she's not busy writing, Maurie can be found hiking, walking her dogs, driving her kids to their various sports practices and games, and curling up with a good book. She cooks on occasion and bakes way too often.
