Key Takeaways 

  • The benefits of cost segregation may be compounded by working with other tax strategies, such as 1031 exchanges and applicable bonus depreciation rules. 
  • Taxpayers can often catch up on missed depreciation deduction opportunities if a study was not performed at acquisition. 
  • KBKG, the only cost segregation provider that averages 5/5 stars on Google reviews, offers a free calculator to estimate potential savings instantly.  

$839,600 – Those are the first-year tax deductions KBKG uncovered for a real estate investor and his 55,200-square-foot self-storage facility using their engineering-based depreciation analysis. Large real estate developers and Fortune 500 companies have been using cost segregation studies over the past two decades to increase cash flow on their real estate holdings. However, partnerships and private investors often overlook this strategy approved by the Internal Revenue Service (IRS) due to a lack of awareness. 

For the 2024 tax year, cost segregation remains a valuable tax planning strategy under the current MACRS depreciation rules, with qualifying assets eligible for 60% bonus depreciation. Under prior law, bonus depreciation was scheduled to decrease to 40% for 2025. However, the One Big Beautiful Bill Act (“OBBBA”) permanently restored 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, eliminating the previously scheduled phase-down. As a result, taxpayers may immediately deduct 100% of the cost of qualifying assets identified through a cost segregation study, significantly accelerating depreciation deductions and improving cash flow. 

What is Cost Segregation?

Costs associated with acquiring, constructing, or improving a building can be deducted from a Taxpayer’s tax bill over decades. 39 years is the default period for most commercial buildings, while 27.5 is the default period for residential rental buildings. A cost segregation study uses accounting and engineering methods to correctly identify certain assets in and around a building so that they can be written off faster compared to those default periods. These faster write-offs apply to both federal and state income taxes, allowing for significant cash flow increases in the current year. For example, $39,000 invested into a building would allow for a yearly tax deduction of about $1,000 over a period of 39 years. However, if a cost segregation study changed the depreciation period from 39 years to 5 years, the yearly deduction would be almost $8,000 over a period of 5 years – an eightfold increase in tax deductions. This acceleration of tax deductions is what has made cost segregation studies popular with the savvy investor. 

See IRS Publication 946, How To Depreciate Property for MACRS recovery periods and IRC Section 1245 and IRC Section 1250 for asset classification background. 

One of the easiest ways to picture how cost segregation works is to look at a building as one bucket of costs versus four separate buckets of costs. Initially, a building can be considered entirely as 39-year property. That’s the “one-bucket” approach. KBKG often explains this through a “four-bucket” depreciation framework: instead of treating the entire building as one long-term asset, a cost segregation study separates eligible assets into 5-, 7-, 15-, and 27.5- or 39-year recovery periods. Although the “one-bucket” approach is easiest, it is also the most costly because it makes an incorrect assumption that deprives a taxpayer of accelerated depreciation he or she is entitled to. By contrast, the “four-bucket” approach correctly gives the taxpayer three additional shorter recovery periods that allow for immediate tax savings. 

Eligible Property Types and Components

Several building assets qualify for inclusion in these shorter write-off periods. Some examples include certain electrical outlets, telephone/data outlets, kitchen sinks and piping, carpeting, vinyl flooring, decorative and excessive lighting, parking lots, landscaping, and more. The rules governing whether assets qualify for these shorter recovery periods are very complex and generally will require an engineering-based analysis. Additionally, knowledge of the construction process and experience in cost estimating, cost allocation, and blueprint analysis is necessary for what the Internal Revenue Service (IRS)deems a “quality” cost segregation study according to its Cost Segregation Audit Techniques Guide. 

Combining Cost Segregation with Other Tax Strategies

Cost segregation can be used as a stand-alone strategy or in addition to other tax strategies to make the benefits even greater. A large portion of real estate transactions throughout the country are made through 1031 exchanges because they allow taxes on gains to be deferred while allowing investors to acquire even larger properties. By combining cost segregation studies with 1031 exchanges, real estate investors can grow their portfolios while maintaining large tax deductions and deferring gains at each sale. Additional benefits of a cost segregation study include the ability to identify tax-deductible demolition costs and partial disposition deductions when improvements are made to the property. 

Cost segregation studies can be performed on virtually every type of building. There are, however, some cases where a study may not yield enough benefit to the taxpayer or may be discouraged under the current tax code. Because each situation is unique, taxpayers should consult with their accountants and cost segregation engineers to determine if a cost segregation study makes sense for their tax situation. 

KBKG’s cost segregation specialists work alongside taxpayers and their CPAs to evaluate how a study fits within a broader real estate tax plan. This coordinated approach helps investors consider accelerated depreciation in the context of their other transactions and cost recovery objectives rather than viewing cost segregation as an isolated strategy. 

Catching Up on Missed Deductions

A previous lack of awareness of cost segregation doesn’t translate to lost deductions. Tax regulations allow taxpayers to correct depreciation mistakes and retroactively “catch up” missed deductions provided by a cost segregation study in the current tax year. Although a cost segregation study can be performed at any time over the duration of ownership, it is generally best to have one performed as soon as possible, preferably at the time of acquisition or completion of construction. This timing maximizes the potential deductions and increases cash flow sooner rather than later. 

Taxpayers considering a retroactive study should also review IRS Form 3115, which is commonly used to request an accounting method change for depreciation adjustments. 

In today’s complex real estate market, where making the next deal pencil out is getting tougher, cost segregation and its cash flow-increasing capabilities can help strengthen a balance sheet and potentially turn a once-unprofitable deal into a worthy prospect. 

For property owners who believe they may have missed depreciation opportunities, KBKG’s retroactive cost segregation review can help evaluate available catch-up opportunities and provide supporting documentation for implementation when applicable. 

Frequently Asked Questions 

How do I find cost segregation services near me?
Cost segregation studies are not site-dependent, so top providers work nationally using virtual walkthroughs and detailed cost documentation to deliver IRS-defensible studies anywhere in the country. However, KBKG combines that national scale with real regional offices across the U.S., giving you engineers and tax professionals who understand local construction costs and state-specific tax treatment, backed by the same proprietary methodology and audit defense support on every study. When comparing providers, prioritize engineering-based analysis over desktop estimates, included audit defense, and a track record with your property type.  

Can cost segregation be used for residential rental property?
Yes. Residential rental properties, including single-family rentals, multifamily buildings, and short-term rental portfolios, qualify for cost segregation just like commercial buildings. The study identifies components such as appliances, flooring, cabinetry, and landscaping that can be depreciated over 5, 7, or 15 years instead of the standard 27.5-year residential schedule, which is often where the largest acceleration opportunity sits for rental owners.  

How can I estimate my savings before starting a cost segregation study?
Owners can get a preliminary estimate of potential tax savings using KBKG's free cost segregation calculator, which takes basic property details (purchase price, property type, and land value) and provides a ballpark of the first-year depreciation benefit. It's a quick way to gauge whether a full study is worth commissioning before investing in the engineering-based analysis. 

CJ Aberin is a senior manager at KBKG, Inc., Cost Segregation Specialists in Pasadena.

Author: CJ Aberin | Publication: Real Estate Journal - Southern California