Thought leadership provided by Eddie Price | Principal – Cost Segregation
For a long time, the concept of cost segregation has been a powerful tax-saving strategy for real estate investors, enabling property owners to significantly increase their cash flow by accelerating depreciation on certain assets. With the phasing down of bonus depreciation — from 100% to 80% in 2023, 60% in 2024, and an expected reduction by 20% in subsequent years — some investors may wonder if cost segregation is still worth it.
The answer is a resounding yes. Even with the reduction in bonus depreciation rates, cost segregation remains a valuable strategy for maximizing tax savings. Here are six reasons cost segregation continues to benefit taxpayers.
No. 1 - Accelerated Depreciation Benefits
Cost segregation studies identify specific property components (e.g., cabinetry, special purpose electrical components, etc.) that can be depreciated over shorter periods (typically 5, 7, or 15 years) rather than the standard 27.5 years for residential rental property or 39 years for commercial property. By accelerating depreciation, taxpayers reduce their taxable income, resulting in lower tax payments and greater cash flow. These extra funds can be reinvested into the business, used for debt service, or allocated toward new investments.
Reclassification to shorter recovery periods still front loads depreciation in the early years by using the 200% declining balance method for 5- and 7-year property and the 150% declining balance method for 15-year property. Even with decreasing bonus depreciation rates, the resulting cash flow impact can be significant.
No. 2 - Flexible Planning for Tax Deferral
The reduction in bonus depreciation may actually lead to more sustainable, long-term tax benefits for many clients. With full 100% bonus depreciation, property owners often had far more deductions than could be used in the initial year placed in service. Any unused deductions can be carried forward to future tax years, but they can only offset up to 80% of taxable income in any single year.
As bonus depreciation eventually phases out, the short-life basis allocations that are spread over future years may allow taxpayers to plan deductions more strategically, aligning them with years when their taxable income may be higher and their need for deductions greater.
No. 3 - Estate Planning
When a building owner dies and property is inherited, any gains built up during the decedent’s life are forgiven. The beneficiary receives a “step up,” meaning the property’s tax basis is reset to fair market value on the date of death and depreciation starts all over. A cost segregation study on the decedent’s pre-stepped up basis can maximize the current year deductions. Since any resulting gains are forgiven, the result is a permanent tax benefit.
No. 4 - Qualified Improvement Property
With a few exceptions, qualified improvement property (QIP) is any real property improvement made by the taxpayer to an interior portion of a nonresidential building placed in service after the date the building was first placed in service. QIP is recovered over 15 years using the straight-line method and is eligible for bonus depreciation.
When the bonus rate was 100%, there was no incentive to identify and segregate 5- and 7-year personal property from 15-year real property improvements as all of it was fully depreciated in the initial year placed in service. As the bonus rate declines, more basis remains to be spread over a 15-year straight line versus 5- or 7-years using the 200% declining balance method. This will compel some taxpayers to segregate the cost of improvements they might otherwise have considered QIP.
No. 5 - Residual Benefits Over the Life of the Property
Cost segregation is primarily used to accelerate depreciation, but it can also provide residual benefits in the event of future property improvements and renovations. The careful identification of building components in a cost segregation study makes it possible to calculate and deduct the remaining basis of those components when disposed of in a renovation.
No. 6 - Additional State Tax Incentives
Some states offer specific tax incentives or tax credits for investments in property improvements, and a cost segregation study can help establish the basis that is eligible for those incentives and credits. Many states have decoupled their state income tax from the federal bonus depreciation rates, allowing different depreciation rules at the state level. cost segregation studies help taxpayers optimize federal and state tax positions, ensuring the maximum benefit across the board.
Conclusion
While the phasing out of bonus depreciation might appear to lessen the appeal of cost segregation, the reality is that it remains an incredibly effective tax planning strategy. With benefits extending beyond immediate bonus depreciation, it still delivers valuable tax savings, improved cash flow, and better long-term flexibility for property owners.
The advantages of cost segregation go beyond any single legislative change, making it a lasting tool in the savvy investor’s tax strategy toolkit. For those looking to maximize their real estate investment returns, a cost segregation study remains a worthwhile investment for years to come.
Action Steps
To learn more about cost segregation and find out if a study is right for you, contact KBKG today or visit KBKG.com.
About the Authors
Eddie Price | Principal – Cost Segregation
Eddie Price is a Principal with KBKG and currently oversees the Southern region and its Texas-based operations. He is a Certified Cost Segregation Professional (CCSP) with the American Society of Cost Segregation Professionals (www.ASCSP.org). With over 40 years of cost segregation experience dating back to the Investment Tax Credit period, Eddie Price is one of the most experienced experts in the industry. Read More.