Benefits of Cost Segregation as a Tax Planning Strategy

Aaron Ammerman |

Cost segregation is a tax planning strategy commonly used by real estate investors to accelerate depreciation deductions and potentially reduce their overall tax liability. By segregating assets within a real estate property and classifying them into shorter recovery periods, investors can depreciate certain components of the property at an accelerated rate, providing immediate tax benefits. Here are some tax benefits of cost segregation:


1. Increased Depreciation Deductions: Cost segregation allows investors to allocate costs to specific assets within a property, such as personal property, land improvements, or shorter-lived building components. By accelerating the depreciation of these assets, investors can claim larger deductions in the early years of ownership, reducing taxable income and potentially generating cash flow.


2. Shortened Recovery Periods: Under the Modified Accelerated Cost Recovery System (MACRS), different assets have different recovery periods. By reclassifying assets into shorter recovery periods through cost segregation, real estate investors can depreciate assets over 5, 7, or 15 years, compared to the typical 27.5 or 39-year period for residential and commercial properties, respectively.


3. Improved Cash Flow: Accelerating depreciation deductions through cost segregation can result in higher deductions in the early years of property ownership. This leads to reduced tax liability and increased cash flow, as the tax savings can be reinvested or used for property improvements, debt service, or other investment opportunities.


4. Opportunity for Bonus Depreciation: Cost segregation can also identify assets that qualify for bonus depreciation, which allows investors to deduct a significant portion (currently 100% under the Tax Cuts and Jobs Act, subject to certain conditions) of the asset's cost in the year it is placed in service. This provides immediate tax benefits and further enhances cash flow.


5. Deferral of Taxes: By front-loading depreciation deductions through cost segregation, real estate investors can potentially defer taxes by reducing taxable income in the early years of ownership. This can be advantageous in situations where investors expect higher future tax rates or have the opportunity to reinvest tax savings into other ventures.


It's important to note that cost segregation studies must be conducted by qualified professionals, such as tax specialists or cost segregation consultants, who have expertise in the field and can ensure compliance with IRS guidelines and regulations. Each investor's tax situation is unique, so it is advisable to consult with a tax professional to determine the specific tax benefits and implications of cost segregation for your individual circumstances.