Cost Segregation
Cost segregation is a tax strategy that accelerates depreciation deductions on commercial property by reclassifying building components into shorter-lived asset categories, generating significant first-year tax savings.
When you purchase or build a commercial property, the IRS requires you to depreciate the building over 39 years (27.5 years for residential rental property). Cost segregation breaks the property into its individual components and reclassifies many of them into 5-year, 7-year, or 15-year property — dramatically accelerating your deductions.
A cost segregation study is performed by a qualified engineer who identifies components that qualify for shorter depreciation periods. Examples include carpeting (5-year), special plumbing or electrical for specific equipment (7-year), landscaping and parking lots (15-year), and decorative finishes.
Typically, 20-40% of a building's cost can be reclassified into shorter-lived categories. Combined with bonus depreciation, this can generate enormous first-year deductions. For a $1 million property, it's common to see $200,000-$400,000 in accelerated deductions.
Cost segregation studies typically cost $5,000-$15,000 depending on property size and complexity. The rule of thumb is that a study is worthwhile for commercial properties worth $750,000 or more.
You can perform a cost segregation study on properties you've already owned for years using a "look-back" study. The IRS allows you to claim the missed depreciation in a single year through a change in accounting method (Form 3115), without needing to amend prior returns.
Practical Example
A dentist purchases a $1.2 million office building. Without cost segregation, annual depreciation is $30,769 over 39 years. A $10,000 cost segregation study reclassifies $360,000 into shorter-lived assets. With 60% bonus depreciation on the reclassified components, first-year deductions jump to approximately $238,000 — creating $57,120 in tax savings at the 24% rate.