May 13, 2025
Commercial property owners are always looking for ways to reduce tax liability and increase cash flow. One strategy that is gaining more attention in recent years is the cost segregation study. This approach helps accelerate depreciation and tax deductions into the early years of property ownership. Despite its technical nature, cost segregation is based on a simple idea. A building is made up of many parts, and not all of the parts age or wear out at the same pace. Because of that, they don’t necessarily need to be depreciated in the same way. When applied correctly, this strategy can lead to significant upfront tax savings. To help clients, prospects, and others, Wilson Lewis has provided a summary of the key details below.
Depreciation allows property owners to recover some of the cost of a building over time. Under the Modified Accelerated Cost Recovery System (MACRS), commercial real estate is typically depreciated evenly over 39 years. But not every part of a building lasts that long. Items like flooring, lighting, HVAC systems, and roofing often wear out much sooner.
A cost segregation study breaks down the building into components that can be depreciated over a shorter time, usually 5, 7, or 15 years. This moves some deductions into the early years of ownership, which generally reduces taxable income and improves cash flow.
Consider a $2 million commercial property. Without a study, the entire building would be depreciated evenly over 39 years, resulting in about $51,000 in deductions each year. But if a study identifies $400,000 of that cost as short-life property, the owner could take a 40% bonus depreciation deduction (in 2025) on that portion in the first year. The remaining amount would be depreciated over the next several years, depending on the asset type. Combined with the standard building depreciation, the total year-one deduction could exceed $200,000. That kind of acceleration can lead to substantial tax savings and improved cash flow.
Cost segregation doesn’t change the total amount of depreciation. It simply moves a portion of it forward, where it can be used for debt reduction or reinvestment.
Cost segregation can be beneficial for commercial or income-producing residential properties. It generally applies to newly acquired buildings, new construction, and major renovations or improvements.
A wide range of property types may qualify. Office buildings, medical facilities, industrial warehouses, retail centers, apartment complexes, hotels, and even self-storage facilities can all benefit from a study. Properties with significant interior finishes, land improvements, or specialized build-outs often yield the highest reclassification potential.
Importantly, a study doesn’t have to be done in the same year the property was placed in service. Retroactive cost segregation is an option. If a building was placed in service in a prior year but never analyzed, the IRS allows owners to “catch up” on missed depreciation by filing Form 3115 (Application for Change in Accounting Method). This allows the owner to claim the unclaimed depreciation in the current year, often creating a one-time deduction without amending prior returns.
Cost segregation studies can be especially valuable in certain situations. It’s often used when an owner expects a high-income year and would benefit from additional deductions to offset taxable income. It can also create a tax advantage when a property is being refinanced or sold. For some property owners, it can help increase liquidity by freeing up cash that can be used for capital improvements or debt reduction. It’s also effective in managing tax exposure across a portfolio, particularly for real estate investors and developers.
Bonus depreciation has played a major role in the value of cost segregation studies over the past several years. It allows property owners to deduct a percentage of qualifying assets in the year those assets are placed in service, rather than spreading the deductions out over time. For many owners, it’s one of the most effective ways to reduce taxable income early in a project’s life cycle.
Although the 100% rate expired at the end of 2022, bonus depreciation is still available at reduced levels:
The topic remains under discussion in Washington. During a joint session of Congress, the President specifically called for the return of 100% bonus depreciation as part of broader tax reform. While no changes have been finalized, it continues to be a key issue in tax policy conversations.
Even without the bonus provision, accelerating deductions into earlier years can make a difference. In some cases, Section 179D may also apply to qualifying improvements. It’s helpful to explore the options, especially when cash flow is tight or a high-income year is expected.
A cost segregation study generally follows these steps:
Most studies take several weeks (or maybe months) to complete, depending on the size and complexity of the property. The return on investment is often realized in the first year through tax savings alone. However, it’s important to note that a cost segregation study may increase the risk of audit.
For commercial property owners, timing is everything. Cost segregation provides a way to accelerate deductions, improve cash flow, and plan. With bonus depreciation still partially available and economic uncertainty continuing, it may be the right time to evaluate properties already on the books. If you have questions about conducting a cost segregation study or need assistance with another tax or accounting issue, Wilson Lewis can help. For additional information call 770-476-1104 or click here to contact us. We look forward to speaking with you soon.