If you're a real estate investor, you're likely familiar with depreciation—the annual tax deduction that allows you to recover the cost of your property over its useful life. For residential rental properties, the IRS deems this "useful life" to be 27.5 years. But what if you could accelerate a significant portion of that deduction into the first few years of owning the property? That's exactly what a cost segregation study allows you to do.
The Core Concept
At its heart, cost segregation is an IRS-recognized tax strategy that separates a building's components into different asset classes. Instead of treating the entire building as a single asset depreciating over 27.5 years, a study identifies parts of the property that can be depreciated over much shorter periods—typically 5, 7, or 15 years.
Think about your rental property. It's not just a structure; it's made up of many different components:
- 5-Year Property: Carpeting, appliances, cabinetry, certain fixtures.
- 15-Year Property: Land improvements like landscaping, fencing, driveways, and sidewalks.
- 27.5-Year Property: The structural components of the building itself, like the foundation, walls, and roof.
By segregating these costs, you can take much larger depreciation deductions in the early years of ownership, which can dramatically lower your taxable income and increase your cash flow.