Is a Cost Segregation Study a Good Choice For Me?

Cost segregation can offer powerful tax benefits for real estate investors, but it’s not a one-size-fits-all solution. In some cases, the upfront cost of a study may outweigh the benefits, or the timing may not align with your goals. This page is designed to walk you through some key considerations so you can make an informed decision.

If you feel cost segregation could be right for you, we invite you to schedule a free discovery call to explore your scenario in more detail.

  • Accelerating your depreciation can still create a tax benefit, especially if you are able to use the losses to offset other income. If you don’t have other income that can be offset, that definitely limits one of the primary benefits that a cost segregation study provides. It could still be worth it for some investments, providing larger loss carry-forwards and an accurate accounting of segregated assets allowing for more aggressive Partial Asset Disposition claims in the future.

  • Luckily, no! There is a method available to implement a cost segregation study in the current year. This involves a special form and what’s called a §481(a) “adjustment.” This is fairly complicated but can be done by an experienced professional. Rarity Tax offers this service for a premium over a same-year cost segregation study.

  • This can add a ton of benefit to a cost segregation study, especially if you have other income in the current year or expect to in the near future. If eligible, the full amount of the increased deductions from the study can be applied to other income. This can result in massive savings for investors with day jobs or spouses who work.

  • Generally, the more you paid for your property (minus land value, which is never depreciable), the greater the benefit of a study. This doesn’t mean that lower-value properties aren’t worth it, just that it factors into the equation. Especially if you can circumvent passive activity loss limitations and have other income, implementing a study may very well still be worth the time and expense.

  • Even with no bonus depreciation at all, a cost segregation study will still shorten the recovery periods of the same assets. This often means cutting the amount of time it takes to fully depreciate those assets by over 80%. Any amount of bonus depreciation is icing on top. So while it certainly changes the equation, plenty of benefit can still be found at 80%, 60%, or even 0% bonus depreciation.

  • Somewhat. The longer you have been depreciating a property, the lower the amount of your adjustment because you have already taken a portion of the deductions found in the study. A general guide for determining this impact would be to take the number of years you have been depreciating divided by the total recovery period (27.5 or 39 years). That will give you a percentage that you can reduce your estimated adjustment by. Is it 10%? Probably no big deal. At 50% it’s likely time to consider if it is still worth it.

  • Here comes in the main downside to a cost segregation study. The more depreciation taken on a rental property, the more depreciation recapture will have to be paid upon selling. The closer a study is to a sale, the bigger the negative effect.

    If you think you may sell soon, the right decision will come down to your current other income, the amount of potential savings, and your other financial goals and interests. Thanks to something called the “time value of money,” money now is generally better than money later. Selling soon, however, can negate some of that benefit, especially if you can’t utilize those passive losses first.

    One way to avoid depreciation recapture is something called a §1031 exchange. This allows an investor to defer capital gains tax and depreciation recapture but involves strict timelines buying a replacement property and a third party intermediary.

  • Past or future renovations, including small ones and appliance upgrades, do not negatively affect the results of a study (as long as the previous condition of the improved assets can be reasonably determined). In fact, it actually gives an investor all the more reason to consider one!

    A cost segregation study will separate out many of the individual components of a building, even many that don’t have a shorter recovery period like a roof or siding or HVAC system. This opens up an opportunity to report Partial Asset Dispositions (PADs) for any component that is removed or replaced during a renovation. This can sometimes be done retroactively for improvements you’ve made before completing the study (although it would have to be considered an entire asset, not a partial one). PADs are an often overlooked benefit by real estate investors and even tax professionals that can sometimes create large tax advantages.