You likely already recognize the power of depreciation as a tax deduction. What you may not know, however, is how the big players have used cost segregation for decades to front-load depreciation to effectively wipe out their taxable income year after year.
In this post about cost segregation for dummies, we’ll explore how the tax strategy works. Further, you’d be pleased to know that cost segregation is no longer an exclusive tool for the big players, requiring a massive investment in money and time.
Firms like Seneca Cost Segregation have democratized the process, making detailed engineering-based studies available to all investors. See if your property qualifies for cost segregation—contact our team today for a free preliminary analysis of your property.
What Is Cost Segregation?
In real estate depreciation, you allocate the cost basis over the property’s useful life. The IRS allows you to do this over 27.5 years (residential) or 39 years (commercial).
What makes up the depreciable value of a property? Well, consider the typical residential property. It has the core building structure (real property) and several personal assets such as landscaping, carpets, lighting fixtures, upgraded cabinetry, driveway, fire protection equipment, appliances, and swimming pool.
Many of these assets won’t last 27.5 years. However, if you do nothing, the IRS will be perfectly fine with you allocating your entire cost basis over 27.5 years.
You can be proactive, though. With cost segregation, you can tell the IRS how much of your property is shorter-life assets that won’t last 27.5 years, so you can subject them to shorter depreciation schedules consistent with their actual useful lives.
How Does Cost Segregation Work?
The IRS provides detailed cost segregation guidelines to govern every cost segregation process. It offers guidance on how to classify various assets. For instance, this is how long the IRS expects various property components to last:
- Five years: Personal Property – wall coverings, decorative lighting, fire protection equipment, blinds and window treatments, carpeting, appliances, etc.
- Seven years: Office and retail personal property – office furniture and equipment, and fixtures such as shelves, counters, and cabinets.
- Fifteen years: Site/Land Improvements – landscaping, driveways, walkways, fencing, swimming pools, septic systems, outdoor lighting, etc.
- 27.5 or 39 years: Real Property – the core building structure.
Cost segregation helps you separate the real property that lasts 27.5/39 years from the personal property and site improvements that only last five, seven, or fifteen years.
You can then front-load much of your property’s depreciation by allocating the costs of these shorter-life assets entirely in five, seven, and fifteen years. You’ll have bigger deductions upfront, lowering your tax bill and freeing up cash for reinvestment.
Where Bonus Depreciation Fits in Cost Segregation Strategies
One of the benefits of doing cost segregation is that it helps you qualify for bonus depreciation. Also called Additional first-year depreciation, bonus depreciation is a tax incentive that allows you to deduct a significant portion of the cost of a qualifying asset in the first year.
Bonus depreciation applies to property with recovery periods of 20 years or less. Because the personal property and site improvements identified by cost segregation have useful lives of five, seven, or fifteen years, they qualify for bonus depreciation.
The Tax Cuts and Jobs Act (TCJA) of 2017 initially allowed for 100% bonus depreciation with the following phase-out schedule:
- Up to 2022: 100%
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
Given the success of the TCJA, there was strong bipartisan support to entrench some of its key provisions. The One Big Beautiful Bill Act, signed into law on July 4, 2025, did exactly that. Bonus depreciation is now permanently back to 100% for properties put in service after January 19, 2025.
How Bonus Depreciation Works
As mentioned earlier, instead of spreading the cost of an asset over its useful life, bonus depreciation allows you to front-load a significant portion in the first year.
Let’s explore how that would look in real life with a cost segregation example with bonus depreciation.
Consider a property with the following details:
- Property Type: Residential
- Purchased for: $1,000,000
- Improvements Made: $50,000
- Land Value: $150,000
- Cost Basis: $900,000 ($1M + $50K – $150K)
- Put in Service: 2024
Because the property was put in service in 2024, 60% bonus depreciation applies, meaning you can deduct 60% of the cost of the Personal Property and Site Improvements in the first year.
Assume Seneca Cost Segregation does a study and finds the following:
- 12% of the cost basis is Personal Property (five years useful life), and
- 16% is Site Improvements (fifteen years useful life).
Therefore:
Personal Property Depreciation = 12% x cost basis = 12% x $900,000 = $108,000.
Site Improvements Depreciation = 16% x cost basis = 16% x $900,000 = $144,000.
The remaining 72% stays as Real Property (27.5 years depreciation) = $900,000 x 72% = $648,000.
What will the total first-year deduction be?
- $108,000 x 60% = $64,800 (the remaining 40% comes in over the next 5 years)
- $144,000 x 60% = $86,400 (the remaining 40% comes in over the next 15 years)
- Real Property = $648,000 / 27.5 = $23,563.64 every year until Year 28
The total first-year deduction = sum of all = $64,800 + $86,400 + $23,563.64 = $174,763.64
Note: Without cost segregation and bonus depreciation, you’d have depreciated the entire $900,000 cost basis linearly over 27.5 years, giving you a yearly deduction of $32,727.27.
Therefore, the Additional First-Year Depreciation is $174,763.64 – $32,727.27 = $142,036.37
You’ll get a tax deduction of $142,036.37 instead of $32,727.27. At a 39% federal tax rate, this nets you a check from the IRS for $55,394.18.
Key Benefits of Cost Segregation for Property Owners
You can unlock several benefits with cost segregation. Let’s explore some of the key ones.
- You qualify for bonus depreciation: It allows you to accurately classify personal property and site improvements, making it possible to take advantage of bonus depreciation.
- Better returns in the long run: Instead of waiting decades for deductions, you can front-load a significant portion. Reinvesting the additional tax savings leads to better returns because you’ll compound a larger initial amount over time.
- Improved cash position: Reducing your tax liability improves cash flow. It has several knock-on benefits. For instance, you’ll be liquid enough to snap up good deals when they hit the market.
Most importantly, cost segregation gives you a proactive tax planning strategy. Instead of waiting for tax time to start scrambling for deductions, you can do cost segregation year-round to lock in massive tax savings early.
How to Do a Cost Segregation Study
We recommend hiring a professional firm rather than doing your own cost segregation study. Aside from the extensive IRS guidelines you must abide by, you also need the experience to know what to look for and how to accurately classify it.
There are several approaches to doing a cost segregation study. We’ve found an engineering-based approach to be the most robust, as it leads to far more accurate classifications and highly defensible reports that can stand up to IRS scrutiny.
That said, a cost segregation study will generally involve the following steps:
- Preliminary analysis: You need a feasibility analysis to determine if the study is worthwhile. Many firms are willing to do a free preliminary analysis.
- Gathering documentation: Find relevant documentation that can help with the study, e.g., ownership documents, architectural/building plans, invoices, and contractor billing statements.
- Property analysis and classification: The engineers can then inspect the property in person or virtually, review documentation, identify part components, and allocate costs.
- Generation of a cost segregation report: The team then puts together a report detailing their methodology, asset breakdowns and cost allocations, photos and diagrams to support claims, and citations of IRS guidelines to support their decisions.
You can then use the report to prepare and file your taxes. Seneca Cost Segregation provides post-study support so your CPA can use the report effectively.
Common Cost Segregation Misconceptions
While the IRS provides clear guidelines for cost segregation, misconceptions still abound. Let’s address the three most common.
- It’s only for high-value properties: Cost segregation is applicable for any income-producing property with a depreciable basis if the potential tax savings justify the investment.
- It will trigger an IRS audit: The IRS approves of cost segregation. You’ll be fine if you follow IRS guidelines.
- The accountant can handle it: It’s unlikely your accountants can do a defensible study if the firm doesn’t have a dedicated cost segregation department.
Getting Started with Cost Segregation Services
Cost segregation services aren’t created equal. As stated earlier, an engineering-based study results in the most accurate and defensible reports.
So, how would you go about finding the best cost segregation company for you? Here are some benchmarks to help you with your search.
- In-house engineering expertise: You want a firm with in-house engineers. The alternative means higher costs because the firm has to significantly mark up its services to cover outsourcing costs.
- Industry experience: How many studies has the team handled? Are there verifiable testimonials to back up their claims?
- Pricing and transparency: Even though cost segregation isn’t easy, an engineering-based approach means there’s consistency in processes. Therefore, the firm should be able to estimate how much the study will cost and give a reasonable tax savings estimate.
With Seneca Cost Segregation, you’ll get a free preliminary analysis of your property to determine how much you’ll likely save in taxes. The estimate isn’t theoretical. It’s based on clear patterns our engineers have spotted while handling over 10,200 studies nationwide.
Find out how much you can save with a Seneca Cost Segregation study—get a free savings estimate today.
Frequently Asked Questions (FAQs)
We’ve covered significant ground in this post about cost segregation for dummies. Let’s answer some key questions to tie everything together.
Are All Properties Eligible for Cost Segregation?
Your property is eligible for cost segregation if it’s income-producing and has a depreciable basis. As for feasibility, we believe it’s worthwhile if the property is valued at $450,000+.
How Much Does a Cost Segregation Study Cost?
The cost will depend on the firm doing the study and the scope of work. You can always contact a firm to get a free preliminary analysis of your property to establish costs and potential savings.
Who Can Perform a Cost Segregation Study?
There aren’t any limitations on who can do a cost segregation study. That said, we advise against DIY studies as they significantly increase audit risk. Also, the IRS itself recommends that studies be done by qualified and experienced professionals.
Will a Cost Segregation Study Trigger an Audit?
Cost Segregation isn’t wrong and will not trigger an audit if done properly. The alternative is to allocate your entire cost basis over 27.5 or 39 years, which is technically wrong, but the IRS allows it because it nets them more taxes early.
Conclusion
With this cost segregation for dummies guide, you are now equipped to execute a tax planning strategy that was previously only available to the biggest real estate investors.
Firms like Seneca Cost Segregation have changed the landscape, making cost segregation available to all investors nationwide.
You don’t have to wait decades for deductions. Now’s the time to accelerate your investment goals by front-loading depreciation to free up cash for reinvestment.
Contact us today for a free preliminary analysis of your property.
