INSIGHT

Cost segregation strategies for real estate investors 

Mark Leverette • March 25, 2025

Services: Cost Segregation Studies Industries: Real Estate

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Real estate investing offers many paths to building wealth, and savvy investors know that maximizing tax benefits can significantly enhance overall returns. Cost segregation stands out as one of the most powerful tax strategies available to property owners. This approach allows investors to accelerate and maximize depreciation deductions, improve cash flow and save significant amounts in income taxes.  

This article will explore the fundamentals of cost segregation, when to implement this strategy and how working with the right tax professionals can help you navigate the process effectively. 

What is cost segregation? 

Cost segregation is a tax planning strategy that allows real estate investors to identify and reclassify building components into shorter depreciation recovery periods. Rather than depreciating an entire property over the standard 27.5 years (residential) or 39 years (commercial), certain building systems and components can be reclassified to shorter 5, 7 or 15-year class lives. 

For example, certain types of flooring, lighting fixtures, plumbing, landscaping, paving, and specialized electrical systems may qualify for accelerated depreciation. The reclassification triggered by a cost segregation analysis frontloads depreciation deductions, reducing current tax liability and improving immediate cash flow; cash flow that can often be used to pay down debt, fund value-add renovation, or as capital for addition investment. 

When to consider cost segregation 

Cost segregation delivers the most value in specific scenarios: 

• Property acquisitions: When purchasing commercial or residential investment property with a building basis exceeding $1 million 
• New construction: During or immediately after completing construction projects 
• Renovations: When making substantial improvements exceeding $300,000 
• Previously purchased properties: Through “look-back” studies for properties placed in service in prior years 
• Basis step up event: When there has been a recent transfer of property that has resulted in a basis step up, oftentimes through a death or inheritance. 

“There is no limit to how far back Cost Segregation studies can look for properties acquired in prior years, but the benefits of accelerated depreciation do diminish over time, As such, many professionals in this field focus on properties acquired or improved within the last 15 years” – Mark Leverette, Partner, Assurance and Advisory  

The cost segregation process 

A professional cost segregation study typically involves four key phases: 

1. Feasibility analysis 

Before committing to a full study, tax professionals assess whether cost segregation will deliver meaningful benefits based on your tax situation and property characteristics. This preliminary analysis helps determine if proceeding with a complete study makes financial sense. 

2. Information gathering 

Your tax advisors will collect relevant property documentation, which may include: 

• Property condition reports 
• Appraisals 
• Site maps or surveys 
• Purchase documents 
• Construction drawings 
• Contractor invoices 
• Change order details 

3. Property analysis 

This phase involves a detailed examination of the property, either in-person or virtually, to: 

• Document building components with photos 
• Review construction plans and specifications
• Classify costs according to appropriate recovery periods
• Identify land improvements and personal property 

4. Final documentation 

The completed cost segregation study produces a narrative report containing: 

• Description of the project and scope of work 
• Detailed findings and tax savings calculations
• Outline of approach and methodology -applied
• Summary of key tax law references 
• Listing of asset classifications and recovery periods 

Tax benefits and considerations

Depending on property type and characteristics, cost segregation typically reclassifies 10-40 percent of a building’s depreciable basis into shorter-life assets. Multifamily properties and office buildings often yield higher reclassification percentages than industrial buildings. 

The accelerated depreciation creates larger tax deductions in early ownership years, which can: 

• Reduce current tax liability 
• Improve cash flow 
• Offset passive income 
• Create loss carryforwards 

However, investors should consider potential drawbacks: 

• Depreciation recapture may apply when selling the property 
• The study itself requires an upfront investment 
• Proper documentation is essential for IRS compliance 

Additional tax opportunities 

The detailed analysis performed during cost segregation often reveals other tax-saving opportunities: 

• Energy efficiency deductions: Properties built to energy efficient standards may qualify for a Section 179D deduction—up to $5.65 per square foot (for 2024) under the Inflation Reduction Act 
• Retirement loss deductions: When replacing building components in the future, established depreciation basis allows claiming “partial asset disposition” deductions 
• Cost recovery for tenant improvements: Identifying leasehold improvements that may qualify for accelerated depreciation 

Choosing the right approach 

The IRS Cost Segregation Audit Guide (“ATG”) identifies preferred methodologies: 

• Detailed engineering approach using actual costs 
• Detailed engineering cost estimates 

The ATG specifically discourages using simple “rule of thumb” methods, which lack reliability and supporting documentation.  Taxpayers who have tried to take a DIY approach to Cost Segregation have been met with mixed results and are often inconsistent with the requirements outlined in the Cost Segregation ATG.  A professional analysis will not only keep you compliant, but also usually produces significantly better tax outcomes. 

Working with BPM  

Implementing cost segregation strategies requires specialized knowledge and experience. BPM provides comprehensive cost segregation services tailored to your specific investment properties and tax situation. Our in-house specialists can work closely with you to identify opportunities, conduct thorough analyses and develop documentation support designed to withstand IRS scrutiny. 

By partnering with BPM for your cost segregation needs, you gain access to seasoned professionals with decades of specialty tax experience but also understand the nuances of real estate tax planning.   

Our Cost Segregation team can help you maximize your tax savings while maintaining compliance. We can guide you through each step of the process, from initial feasibility analysis to implementing the results on your tax returns, ensuring you capture every available tax advantage for your real estate investments. For more information, contact us.