How a Cost Segregation Study Can Reduce Your Taxes and Benefit Your Investment Property

Cost segregation studies are a powerful, but often overlooked, tool for investment property owners. 

This strategic approach to asset depreciation can help enhance your returns, maximize tax benefits, and unlock hidden value in your real estate investments. 

We highly recommend speaking with your Certified Public Accountant or tax preparer to determine if a cost segregation study is beneficial for you. 

What is a Cost Segregation Study? 

Cost segregation is a way for real estate investors to deduct the depreciation of a property against their taxable income. 

Cost segregation is not available for primary residences, but it can be used on residential real estate owned as an investment. 

Depreciation is a deduction that real estate investors can claim on their income taxes each year to help them recover the cost of owning, operating, and maintaining an investment property. Cost segregation allows you to “speed up” the depreciation schedule, increasing the amount you can deduct each year.

For example, instead of having to depreciate an entire property over 27.5 or 39 years, you may be able to claim deductions for certain systems in your building, such as electrical or plumbing fixtures, over 5, 7, or 15 years. 

How to Conduct a Cost Segregation Study 

A cost segregation study can show you how to maximize the tax deductions from your investment property. It’s best to order a cost segregation study through your Certified Public Accountant or tax preparer.

You will need to take account of the different components of your investment property, including plumbing fixtures, roofing, electrical systems, sidewalks, driveway, flooring, and other materials.

If you bought these items separately, you are allowed to depreciate them over 5 to 15 years. But if these items were already part of the building that you purchased, you can only depreciate them over 27.5 years if you purchased a residential building, or 39 years if you bought a commercial property.

You may also need to supply documents regarding your investment property, including a recent appraisal of the property, inspection reports, or the closing documents.

When Should You Order a Cost Segregation Study? 

While you can order a cost segregation study at any time, the best time is during the same year that you bought, built, or remodeled your investment property to maximize on savings when you’re spending the most. 

If you haven’t recently built, purchased, or remodeled your property, you can still take advantage of this tax strategy by ordering a look-back study. 

A look-back study is a type of cost segregation that allows you to claim a catch-up tax deduction in a single year. The amount of the deduction will be equal to the difference between what you originally claimed as depreciation on your investment property and what you could have claimed if you performed a cost segregation study earlier.

Under IRS rules, you are allowed to perform a look-back study on properties that you purchased, built, or remodeled as far back as Jan. 1, 1987.

Closing Thoughts

Cost segregation is a great tool for investment property owners to help maximize their tax benefits. Even if you’ve missed the recent window, a look-back study can help you make up for any lost opportunities. Cost segregation is also a great strategy to increase your cash flow and help you continue to build your investment portfolio. 

Speak with your tax preparer or Certified Public Accountant to determine if a cost segregation study is beneficial for you.