Cost segregation and bonus depreciation are two powerful tax strategies that, when combined, can significantly reduce taxable income for real estate investors and business owners. Understanding how these methods work together can help maximize deductions and improve cash flow.

What is Cost Segregation?

Cost segregation is a tax strategy that allows property owners to accelerate depreciation deductions by identifying and reclassifying certain building components into shorter depreciation schedules. Instead of depreciating an entire building over 27.5 years (residential) or 39 years (commercial), cost segregation breaks out components such as:

  • Land improvements (e.g., landscaping, parking lots) – 15-year depreciation
  • Personal property (e.g., lighting, carpeting, cabinets) – 5 to 7-year depreciation

By reallocating these components into shorter life categories, investors can accelerate depreciation expenses and reduce taxable income earlier in a property’s life.

What is Bonus Depreciation?

Bonus depreciation allows businesses to immediately deduct a significant portion of the cost of qualifying assets in the year they are placed in service, rather than spreading the deduction over multiple years. Under the Tax Cuts and Jobs Act (TCJA), bonus depreciation was set at:

  • 100% for assets acquired and placed in service between 2018 and 2022
  • Phasing down starting in 2023 (80% in 2023, 60% in 2024, etc.)

Eligible property includes assets with a depreciation life of 20 years or less—making cost segregation an effective tool to classify parts of a building into these shorter-lived asset categories.

How Cost Segregation and Bonus Depreciation Work Together

Cost segregation enhances the benefits of bonus depreciation by identifying building components that qualify for shorter depreciation periods. Since bonus depreciation applies to assets with a useful life of 20 years or less, a cost segregation study helps property owners unlock these accelerated deductions.

For example, if a commercial property owner purchases a building for $5 million, a cost segregation study may determine that $1.5 million of that amount consists of 5-, 7-, and 15-year property. If the building is placed in service during the 100% bonus depreciation window, the owner can deduct the entire $1.5 million in the first year rather than depreciating it over decades.

Key Benefits of Using Both Strategies

  1. Immediate Tax Savings – Large upfront deductions lower taxable income and reduce tax liability.
  2. Improved Cash Flow – Retaining more capital allows for reinvestment in new properties or business expansion.
  3. Offset Other Income – Bonus depreciation deductions can offset ordinary income, not just rental income.
  4. Strategic Tax Planning – Investors can plan acquisitions around depreciation phase-outs to maximize benefits.

Considerations and Limitations

  • Phase-out of Bonus Depreciation – The 100% bonus depreciation provision started phasing down in 2023 and will continue decreasing until it reaches 0% in 2027 unless extended by future legislation.
  • Recapture Rules – If a property is sold after claiming bonus depreciation, recapture taxes may apply, potentially increasing tax liabilities.
  • Professional Analysis Required – A cost segregation study should be performed by qualified tax and engineering professionals to ensure compliance with IRS guidelines.

Conclusion

Cost segregation and bonus depreciation are essential tools for real estate investors and business owners looking to optimize tax savings. By combining these strategies, property owners can maximize upfront deductions, improve cash flow, and reinvest in future growth. Consulting with a tax professional can help ensure these strategies are applied effectively to meet financial goals.