April 22, 2025 • General
If you own commercial real estate, you’ve probably heard the term cost segregation thrown around—especially at tax time. It’s a powerful tool that can unlock major tax savings, but it’s not always the right move for everyone. Before jumping in, it’s important to weigh the pros and cons. Here’s a closer look at what cost segregation really involves, and the potential advantages and disadvantages you should consider.
What Is Cost Segregation?
Cost segregation is a tax strategy that separates the personal property components of a building (like fixtures, flooring, or special plumbing) from the structural components (like walls and roofs). By doing this, you can depreciate certain parts of the property over a shorter time frame—often 5, 7, or 15 years—instead of the standard 27.5 or 39 years used for residential and commercial real estate.
In simpler terms: it lets you speed up depreciation deductions and reduce your taxable income in the early years of owning a property.
Advantages of Cost Segregation
1. Significant Tax Savings Early On
The biggest draw is the ability to accelerate depreciation and dramatically reduce your tax liability in the first several years of ownership. For many investors, this frees up cash for reinvestment or other business needs.
2. Improved Cash Flow
Because you’re paying less in taxes, you have more cash on hand. This improved cash flow can be critical, especially for newer or growing businesses.
3. Eligibility for Bonus Depreciation
Current tax laws (at least for now) allow for 100% bonus depreciation on qualifying assets. That means even bigger upfront deductions when you complete a cost segregation study.
4. Stronger Return on Investment
Reducing tax payments and freeing up working capital early can significantly boost your return on investment (ROI), especially if you use the savings strategically.
5. Flexibility Across Different Property Types
Cost segregation isn’t limited to huge commercial buildings. It can also apply to rental properties, industrial spaces, retail centers, medical offices, and even certain renovations or improvements.
Disadvantages of Cost Segregation
1. Upfront Cost of a Study
A professional cost segregation study isn’t free. Depending on the size and complexity of the property, it can cost several thousand dollars. For smaller properties, the benefit may not outweigh the cost.
2. Potential IRS Scrutiny
Because cost segregation accelerates depreciation and creates large deductions, it can sometimes attract additional IRS scrutiny. It’s important to use a reputable firm that can back up the study with strong documentation if you ever face an audit.
3. Depreciation Recapture at Sale
When you eventually sell the property, you could face a larger depreciation recapture tax. This means you’ll pay taxes on the amount of accelerated depreciation you’ve taken. In some cases, the savings upfront are still worth it, but you’ll want to plan for this later tax hit.
4. Best Suited for Long-Term Holders
If you plan to sell the property within a few years, the benefits of cost segregation may not outweigh the costs and future tax consequences. It’s generally most effective for investors planning to hold the asset for a longer period.
Is Cost Segregation Right for You?
Cost segregation can be an excellent strategy for maximizing tax savings and boosting cash flow, but it’s not a one-size-fits-all solution. The decision should factor in the size and value of your property, your overall tax situation, your plans for holding or selling the property, and your willingness to navigate potential future tax obligations.
If you’re considering it, it’s smart to consult with your CPA and a trusted cost segregation specialist to see if the numbers truly work in your favor.