The Tax Cuts and Jobs Act (TCJA) of 2017 significantly enhanced the benefits of cost segregation by offering 100% bonus depreciation.
However, it included a phase-out schedule for the incentive, causing uncertainty about the fate of cost segregation as the most powerful tax strategy for real estate investors. Given this reality, is cost segregation going away, or is it still as powerful as ever?
This post examines the fate of cost segregation and explains the changes introduced by a recent piece of legislation that provided a definitive answer to the above question.
What is Cost Segregation?
Cost segregation is a tax strategy that enables real estate investors to reduce their tax liability by accelerating depreciation deductions.
In standard straight-line depreciation, you allocate the entire depreciable basis of a property linearly over 27.5 years (residential) or 39 years (commercial). You may find this approach inefficient, as many property components won’t last that long.
To solve the inefficiency, you can use cost segregation to reclassify property components and subject them to depreciation schedules consistent with their actual useful lives as follows:
- 27.5/39-year life: Real Property (the core building structure)
- 15-year life: Site Improvements (fencing, driveways, pools, etc.)
- 5/7-year life: Personal Property (furniture, carpeting, appliances, etc.)
Subjecting a significant portion of your property to the 5/7 and 15-year schedules accelerates depreciation, leading to larger deductions in the initial years of property ownership.
You’ll get the deductions you’d have gotten anyway, but a lot sooner. It’s valuable because of the power of the time value of money, as a dollar saved or reinvested today is worth more than a dollar 27 or 39 years later.
Is Cost Segregation Going Away?
Cost segregation is a permanent fixture of the tax code, and it is not going away because it is perfectly in line with existing tax laws and court precedents.
A notable precedent is the landmark ruling in Hospital Corp. of America v. Commissioner (1997). The corporation argued that many components of its hospitals were tangible personal property rather than part of the building structure.
The Tax Court agreed and ruled that taxpayers could depreciate these assets using shorter depreciation schedules.
We believe the confusion surrounding the status of cost segregation stems from two factors:
- Some taxpayers are incorrectly conflating bonus depreciation with cost segregation.
- There’s apprehension about the fate of bonus depreciation, given the phase-out schedule in the 2017 TCJA.
We’ll address these two issues later on in this post.
Key Benefits of Cost Segregation
Cost segregation offers real estate investors the following key benefits:
- Improved cash position: Larger deductions mean you get to keep more of your money instead of giving it to the IRS. With increased liquidity, you can grow your portfolio without relying only on expensive loans.
- Better returns over time: When you accelerate depreciation and reinvest the tax savings early, you’ll get better portfolio returns because you can compound the growth over a longer timeframe.
- Enables you to utilize bonus depreciation: Assets with recovery periods of 20 years or less qualify for bonus depreciation. Therefore, the 15- and 5/7-year properties that benefit from cost segregation also qualify.
Also referred to as Additional First Year Depreciation Deduction, bonus depreciation is a tax incentive that allows you to deduct up to 100% of the cost of an eligible asset in its first year.
The rate depends on the year the property was placed in service. For instance, if you do a cost segregation study for a property placed in service in July 2025 and find that $171,000 of the cost is 5- and 15-year property, you can write off the entire $171,000 in year one.
Bonus Depreciation Changes and Their Impact on Cost Segregation
When enacted in 2017, the TCJA allowed for 100% bonus depreciation through 2022, phasing it out as follows:
- Up to 2022: 100%
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
The legislation was largely a success, and there was strong interest in cementing its key provisions, including bonus depreciation.
That objective was achieved with the passage and subsequent signing into law of the One Big Beautiful Bill Act, which reinstated 100% bonus depreciation for properties placed in service after January 19, 2025.
Here’s what this means:
- Bonus depreciation is no longer a temporary incentive. You can leverage it as a long-term tax planning tool.
- The rates in the phase-out schedule above apply until January 19, 2025. For instance, if you placed a property in service on January 17, 2025, it qualifies for 40% bonus depreciation. Beginning January 20, 2025, 100% bonus depreciation applies.
In other words, if the uncertainty around the fate of bonus depreciation made you question the future of cost segregation, you can now rest easy knowing that cost segregation and bonus depreciation are not going away.
Common Cost Segregation Myths That Need Clarification
Some common cost segregation myths may prevent you from fully leveraging it for tax planning.
Let’s address these misconceptions so you can proceed with confidence:
- Cost segregation invites audits: The IRS approves of cost segregation. In fact, it is the correct way to handle depreciation because different property components have different useful lives.
- Cost segregation is for large investors: For many years, cost barriers made cost segregation the preserve of institutional investors. However, firms like Seneca Cost Segregation have leveled the playing field, making the tax strategy available to investors of every size.
- Depreciation recapture makes the strategy futile: Most investors utilizing cost segregation are long-term property investors, limiting the impact of depreciation recapture. Also, working with a good CPA, you can defer recapture tax using exit strategies like 1031 exchanges.
Additionally, we want to clarify that cost segregation is not a loophole. It is a well-established accounting method backed by IRS guidelines and decades of industry practice.
Specifically, the IRS has published a comprehensive Cost Segregation Audit Technique Guide, which gives pointers into what it considers to be a quality cost segregation study.
At Seneca Cost Segregation, we strictly follow IRS guidelines, conducting defensible, engineering-based studies that withstand the highest levels of IRS scrutiny. Our engineers have completed over 10,200 studies nationwide with incredible success using our streamlined process.
Contact us today for an IRS-compliant cost segregation study to reduce or eliminate your federal tax liability.
Is Cost Segregation Still Worth It?
With bonus depreciation back at 100%, cost segregation is as valuable as ever and is still worth it.
However, property depreciable bases and placed-in-service dates vary, complicating the evaluation of whether cost segregation is worth it for specific investors.
The only way to figure out if cost segregation is worth it for you is to run the numbers. Let’s use a cost segregation study example to illustrate the value of the tax strategy.
Assume you placed a residential property with the following details in service in 2024:
- Purchase: $1,000,000
- Improvements made: $50,000
- Land value: $150,000
- Cost basis: $900,000 (Purchase + Improvements – Land value)
If you were to depreciate the property using standard straight-line depreciation, you’d allocate the $900,000 linearly over 27.5 years, giving you a per-year depreciation of $32,727.27.
Now, assume we do a cost segregation study on the property and find that 12% of the cost basis is personal property, 16% is site improvements, and 72% is real property.
- 12% of $900,000 = $108,000
- 16% of 900,000 = $144,000
- 72% of $900,000 = $648,000
Because you placed the property in service in 2024, it qualifies for 60% bonus depreciation, and the treatment is as follows:
- $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 / 27.5 years = $648,000 / 27.5 = $23,563.64 every year until Year 28
The total 1st year deduction = $64,800 + $86,400 + $23,563.64 = $174,763.64
The Additional First Year Depreciation Deduction = $174,763.64 – $32,727.27 = $142,036.37
You’ll then get a tax deduction of $142,036.37 instead of $32,727.27. At a 37% federal tax rate, this nets you a check from the IRS for $52,553.46.
Ready to run the numbers on the property you currently own? Use our free cost segregation calculator to estimate your potential tax savings and determine whether it is worth it for you.
Frequently Asked Questions (FAQs)
Let’s now answer some common questions about cost segregation:
Can Cost Segregation Be Reversed If Tax Laws Change?
No, a change in tax law won’t retroactively change the category an asset falls into.
Cost segregation reclassifies property components into personal property, site/land improvements, and real property and allocates costs to them.
Does Cost Segregation Increase the Chances of an IRS Audit?
If done properly in accordance with IRS guidelines, it’s unlikely that cost segregation will trigger an IRS audit.
At Seneca Cost Segregation, we offer an audit defense guarantee where we defend our audit and report in the unlikely event of an audit.
How Long Has Cost Segregation Been Recognized by the IRS?
The first time a court ruled that taxpayers could depreciate a building by breaking it into its component parts was in 1959, in Shainberg v. Commissioner.
However, modern cost segregation, as it is practiced today, mostly began after the Hospital Corp. of America v. Commissioner ruling in 1997.
Can Cost Segregation Be Applied Retroactively?
Yes, you can do a look-back study on a property placed in service in prior years.
You will need to use IRS Form 3115 to apply for a change in accounting method and claim missed depreciation deductions without amending prior tax returns.
Conclusion
Cost segregation remains a long-term tax strategy grounded in tax laws, court precedents, and engineering principles. It’s not going away.
What has changed is the associated tax incentives. Even so, these incentives have mainly changed for the better. For instance, you can now plan for future tax benefits with bonus depreciation, knowing it no longer has an expiration date under current law.
At Seneca Cost Segregation, we are ready to help you capitalize on this improving landscape. Our studies have consistently helped investors like you turn 20-40% of their property costs into immediate tax savings.
Request a free proposal today, and we’ll send you an estimate of your potential tax savings on the property you currently hold.
