As a savvy real estate investor, it’s likely you already understand that tax savings realized today are worth more than those deferred to the future. In practice, however, many investors do not fully use tools explicitly designed to front-load these savings.
Cost segregation bonus depreciation is one such tool. With cost segregation, you can ‘segregate’ the shorter-life components of your property, depreciate them faster, and capture the tax savings now.
The strategy is IRS-compliant. Even so, consider using professional cost segregation services to avoid mistakes that could expose you to audit risk.
Schedule a free consultation with our team to see if your property qualifies for cost segregation.
What is Cost Segregation?
Real estate investors typically depreciate their properties over 27.5 years for residential properties and 39 years for nonresidential properties.
Let’s say you have a $550,000 single-family property in Austin, Texas, with a land value of $165,000. That gives you a depreciable building value of $385,000 ($550,000 less $165,000).
The typical investor would depreciate the entire $385,000 building value over 27.5 years, claiming $14,000 in annual deductions.
We do know, however, that a building is made up of different components, many of whose useful life is less than 27.5 years. For instance, it’s unlikely that you’ll keep your fire protection equipment for 27.5 years.
The IRS agrees. For example, the IRS provides the following recovery periods for various assets in a residential property:
- Balcony: 27.5 years
- False balcony (ornamental): 5 years
- Fire protection equipment: 5 years
- Mailboxes: 15 years
- Concrete footings: 15 years
- Data cable and wiring: 5 years
- Decks/gazebos (freestanding): 15 years
- Fencing and gates: 15 years
Knowing this, as the owner of the Austin property we discussed above, it would be unwise to spread the entire $385,000 depreciable building value over 27.5 years.
The right move would be to separate the shorter-life assets and accelerate their depreciation to reflect their true useful life. The practice of studying and separating these assets is called cost segregation.
You’d be surprised how much of your property’s value qualifies. At Seneca Cost Segregation, we have consistently helped investors turn 20 to 40% of their property costs into immediate tax savings.
With cost segregation bonus depreciation, our clients average a first-year deduction of $171,243. You’ll learn how bonus depreciation works later on in this post.
Benefits of Cost Segregation
Real estate investors accrue the following benefits from doing cost segregation:
- It reduces your immediate tax obligations: By front-loading a substantial portion of your property’s depreciation, you can claim a higher deduction, thus reducing your tax bill.
- Benefit from compounding growth: Cost segregation helps you compound the impact of time value of money. By saving a lot more taxes early and reinvesting the savings now, you can significantly compound the growth of your portfolio over time.
- It’s like an interest-free loan from the government: What happens when you don’t do cost segregation? You pay taxes that you could have deferred into the future. With cost segregation, you get to keep the money, and instead of going to the bank to borrow at ~7%, you get free money at 0%.
How Cost Segregation Works
You now know what cost segregation is. Let’s dive into what it would look like in practice.
The first thing you must remember is that while you can DIY cost segregation, it is advisable to hire a reputable firm, like Seneca Cost Segregation, with the expertise and experience to comply with all IRS guidelines.
Your chosen firm will conduct a cost segregation study, identify parts of your property that can be depreciated faster, and generate a detailed report that backs the reclassification.
The classification will put these qualifying parts into five-, seven-, and fifteen-year depreciable asset classes.
Let’s take the $550,000 Albany property with a depreciable building value of $385,000 as an example.
Assume Seneca Cost Segregation does a study and finds the following:
- $231,000 (60% of the depreciable value) in parts does not qualify and will have to be depreciated over 27.5 years.
- $77,000 in parts is five-year property (20% of the depreciable value) and can be depreciated entirely over five years.
- $7,700 in parts is a seven-year property (2% of the depreciable value) and can be depreciated entirely over seven years.
- $69,300 in parts is a 15-year property (18% of the depreciable value) and can be depreciated entirely over 15 years.
If you were to depreciate the entire $385,000 linearly over 27.5 years, you’d have a $14,000 deduction every year. With cost segregation, you can claim significant additional depreciation upfront.
If your taxable income is greater than your deductions, you’ll effectively not owe any taxes.
Contrast this to the alternative scenario where you don’t do cost segregation and have taxable income that does not get deducted to $0. You’ll have to pay tax. You’d be willingly giving IRS money that you can otherwise use today to grow your portfolio.
What is Bonus Depreciation?
In traditional depreciation, investors write off assets linearly over their useful life. With bonus depreciation, an investor can immediately write off a significant percentage of the asset’s depreciable value.
The tax incentive, also called the additional first-year depreciation deduction, helps free up cash for small businesses, encouraging them to invest more.
In 2025, bonus depreciation has dropped to 40%, meaning you can write off 40% of the depreciable value of an asset immediately. That said, the Big Beautiful Bill, as it is written as of the time of writing this article, could go back up to 100% for 2025. However, as it stands right now, per the Tax Cuts and Jobs Act (TCJA) passed in 2017, here is the phase-out schedule (SEC. 13201):
- Up to Dec. 31, 2022 – 100%
- 2023 – 80%
- 2024 – 60%
- 2025 – 40%
- 2026 – 20%
- 2027 – 0%
Our view is that there is a high likelihood that Congress will extend bonus depreciation before it phases out in 2027. TJCA has been largely a success, especially for the real estate sector, and there is significant interest in reintroducing and improving it. The government offers bonus depreciation because it frees up money for reinvesting into the economy and makes investors and business owners capital allocators instead of the government.
Bonus Depreciation vs. Section 179
Both bonus depreciation and section 179 are designed to help businesses seeking immediate tax relief.
Under section 179, one can take a business expense deduction for depreciable assets if the full purchase price of the equipment is eligible for the deduction.
Equipment that qualifies includes:
- Heavy machinery
- Vehicles
- Computers
- Software
- etc.
The maximum deduction you can make under section 179, according to the IRS, is $1,220,000. Also, you must have taxable income after making the deduction, meaning you cannot create a loss.
Bonus depreciation doesn’t suffer from the above two limitations. There isn’t a limit, and you can indeed create a paper loss. It would be the way to go if you want to deduct as much as possible now, even if it results in a loss, so you can free up funds to reinvest in your business.
What Qualifies For Bonus Depreciation?
Properties falling under the following categories qualify for bonus depreciation:
- Property must have a recovery period of 20 years or less.
- Both new and used properties qualify.
- Equipment like vehicles and computers where more than 50% of their usage is for business.
- Interior improvements to nonresidential buildings where they meet Quality Improvement Property (QIP) criteria.
How Does Bonus Depreciation Work?
Bonus depreciation lets you deduct a large portion of certain assets’ costs (usually short-lived ones) in the first year instead of spreading it out over many years.
Normally, real estate depreciation happens slowly — over 27.5 or 39 years. But with a cost segregation study, parts of the property (like Personal Property and Site Improvements) are reclassified into shorter-lived assets (less than 20 years), making them eligible for bonus depreciation.
Let’s see an example –
Property Purchase: $1,000,000
Improvements Made: $50,000
Land Value: $150,000 (land is not depreciable)
So, the depreciable basis = $1,000,000 + $50,000 – $150,000 = $900,000
After Cost Segregation, the study breaks down the $900,000 like this:
- 12% = Personal Property → $108,000
- 16% = Site Improvements → $144,000
- 72% = Real Property → $648,000 (depreciated over 27.5 years)
Bonus Depreciation in 2024 = 60%
- Personal Property: $108,000 × 60% = $64,800
- Site Improvements: $144,000 × 60% = $86,400
These are immediate deductions in Year 1.
The remaining 40% is still depreciated over 5 years (for Personal Property) or 15 years (for Site Improvements).
Straight-Line (SL) Depreciation:
The Real Property portion ($648,000) depreciates slowly:
$648,000 ÷ 27.5 years = $23,563.64 per year
Also, without cost segregation, the entire $900,000 would’ve been depreciated using the SL method:
$900,000 ÷ 27.5 = $32,727.27 in Year 1
Net Impact:
- Total First-Year Deduction with Cost Seg = $64,800 + $86,400 + $23,563.64 = $174,763.64
- Without Cost Seg = $32,727.27
- Additional Deduction = $142,036.37
- Tax Savings at 39% rate = $142,036.37 × 39% = $55,394.18
The Relationship Between Cost Segregation and Bonus Depreciation
Bonus depreciation allows you to write off assets immediately, provided they have a useful life of 20 years or less.
Cost segregation helps you utilize the bonus depreciation incentive by identifying the components of your property that can be depreciated in five-, seven-, or fifteen-year timeframes. All these segregated assets have a useful life of under 20 years, so they qualify.
Let’s walk through what it would likely look like in practice:
- You have a $550,000 property in Lake Oswego, Oregon, with a depreciable building value of $385,000 that was put in service in 2025, which is a 40% bonus depreciation year as of right now.
- Seneca Cost Segregation does a study and finds that $154,000 of the depreciable building value has a five-, seven-, or fifteen-year useful life, and qualifies for bonus depreciation.
- At 40% bonus depreciation (40% of $154,000 = $61,600), you elect to take a $61,600 deduction right away.
- In addition, you still get to claim accelerated depreciation on the remaining 60% short-life assets (five, seven, or fifteen years), plus the $8,400 yearly deduction for 27.5 years on the $231,000 long-life building value.
You’ll likely end up with a significant paper loss after claiming the deduction in the first year. What happens to the paper loss? You can carry it forward to offset future years’ net income, so you have several years of zero taxes.
Now, you might be wondering: since bonus depreciation has dropped to 40%, is it still worth it to do cost segregation?
At 40 or 20%, we believe claiming cost segregation bonus depreciation is still worth it for properties valued at $500,000+. You’ll see why based on the time value of money calculation below.
To truly appreciate the benefit of cost segregation bonus depreciation, you must understand the principle of the time value of money.
As stated earlier, our clients average a first-year deduction of $171,243. If you were to spread this amount over 27.5 years, you’d claim approximately $6,227 yearly.
For simple math, let’s assume that:
- Home prices increase 5.2% yearly, and you reinvest the equivalent of the depreciation deductions.
- If you reinvest the entire $171,243 now, you’ll have $690,243 at the end of the recovery period (27.5 years).
- If you reinvest $6,227 yearly for the entire recovery period, you’ll end up with $362,985.
$690,243 – $362,985 = $327,258. You’ll be $327,258 ahead.
A cost segregation study for this type of property should cost a couple of thousand dollars. Would you spend a few thousand dollars to emerge $327,258 ahead?
It’s a no-brainer. Request a free proposal for a property you have with us today to lower your tax bill with a cost segregation study.
Bonus Depreciation vs. Cost Segregation
Cost segregation and bonus depreciation can be combined to capture significant tax savings. However, it is essential to note that they are two different concepts governed by separate guidelines.
Below is a quick summary of how they compare.
| BONUS DEPRECIATION | COST SEGREGATION |
| A tax incentive allowing investors to deduct a large percentage of their properties’ depreciable value upfront. | A way to classify the components of a building into long- and short-life assets. |
| Applies to assets with a 20-year or less useful life. | Cost segregation of short-life assets would result in five-, seven-, and fifteen-year assets. |
| For qualifying assets, e.g., an eligible business vehicle, bonus depreciation is automatically applied unless you opt out. | Cost segregation is elective. The first step would be commissioning a cost segregation study with a firm like ours.
Otherwise, the IRS would be fine with you depreciating your entire property, including its short-life components, over 27.5 or 39 years. |
Best Practices for Combining Cost Segregation and Bonus Depreciation
You want to follow industry best practices when complementing cost segregation with bonus depreciation.
Some of the essential practices you need to know include:
- Timing is important: You should do cost segregation as soon as possible to claim bonus depreciation immediately and benefit from the compounding benefits of time value of money.
- Engineering and professional expertise: It is advisable to contract a reputable firm with engineering expertise to do your cost segregation study. You don’t want to trigger an audit because you made avoidable mistakes.
- Pay attention to IRS rules on REP status or Short Term Rental (STR) material participation requirements: If you meet relevant IRS rules and qualify as a Real Estate Professional (REP), you can do cost segregation and claim bonus depreciation to offset even active income. This applies to people who spend the most time out of anyone participating in an STR.
The REP status idea is important because bonus depreciation creates a passive loss. A passive loss in this case is only used to offset passive income, i.e. passive rental income.
There are exceptions, however, where you can use the loss to offset your active income. For instance, if you spend at least 750 hours in your real estate venture and it constitutes more than 50% of your total working time, you can deduct the losses from your active business income or W-2.
You must consult your CPA before making such cost segregation bonus depreciation deductions to ensure you follow industry best practices and IRS guidelines.
Frequently Asked Questions (FAQs)
Below are the answers to some commonly asked questions about cost segregation and bonus depreciation.
Can Bonus Depreciation Create a Loss?
Yes, bonus depreciation can create a loss. You can use the passive loss to offset other passive income in the same year or carry it forward to offset future passive income.
If you meet certain conditions, and you should consult your CPA in this case, you can even use the loss to offset active business income or your W-2.
What Assets Qualify for Bonus Depreciation?
Assets with a recovery period of 20 years or less qualify for bonus depreciation. Therefore, assets that would benefit from accelerated depreciation under cost segregation would qualify as the recovery periods are five, seven, or fifteen years.
Examples of property components in a residential building that would qualify include:
- Readily removable floor coverings, e.g., carpets
- Fencing, gates, and retaining walls
- Decorative electrical lighting
- Fire protection equipment
- Fountains
- Patios
- Furnishings
- Parking lots
- Exterior mailboxes
- Kitchen appliances
- Parking lot canopies
- Specific land improvements such as sidewalks and canals
Can You Take Bonus Depreciation on Leasehold Improvements?
Yes, you can take bonus depreciation on nonresidential leasehold improvements if they meet Quality Improvement Property (QIP) criteria.
Under QIP rules, improvements must be made to the property’s interior and must have been done after the building was originally placed in service.
Typical improvements that qualify include flooring, plumbing, and lighting improvements, as well as improvements to the interior walls.
Can Cost Segregation Be Combined with Energy Efficiency Incentives?
Yes, you can combine energy efficiency incentives with cost segregation. A cost segregation study can help you get a clear picture of the assets in your property that qualify as energy-saving components.
After the cost segregation, you can take a bonus depreciation and also claim energy efficiency deductions or credits.
To do this correctly, we advise you to consult a CPA familiar with cost segregation, bonus depreciation, and energy efficiency incentives.
Conclusion
Depreciation deduction is one of the most valuable tools for growing your real estate wealth. Think about it—with every other deduction, e.g., insurance premiums, money leaves your pocket, then you claim it later. With depreciation, you get it simply because you own a depreciable interest in the property.
Moreover, with cost segregation and bonus depreciation, you can grow your wealth faster by front-loading the tax benefits that accrue from depreciation deductions.
Therefore, a cost segregation study is a no-brainer, especially if you want to save funds to invest in your next property faster. Find out how much you can save with our free estimate or try our online cost segregation savings calculator today.
