For any property owner under the current tax law, a cost segregation study can provide a significant tax benefit, while the proposed tax laws would provide an even greater benefit if enacted. In the following, we define a cost segregation study, provide a summary of the current and proposed tax laws, and give examples of the cash tax savings a property owner can generate under each scenario.
What is Cost Segregation?
Cost segregation is a tax strategy used by businesses and real estate investors to accelerate depreciation deductions, thereby reducing taxable income and improving cash flow. These studies involve a detailed analysis of a building's components and their respective costs, allowing certain portions of the property to be reclassified from real property to personal property. By doing so, these components can be depreciated over shorter periods (such as five, seven, or 15 years) instead of the standard 27.5 or 39 years for residential and commercial properties. This results in larger depreciation deductions in the early years of ownership, freeing up cash for other investments.
Current and Proposed Tax Laws
In 2017, the Tax Cuts and Jobs Act (TCJA) made significant changes, which allowed taxpayers to depreciate 100% of eligible property purchased and put into service between Sept. 27, 2017, and Dec. 31, 2022. Known as bonus depreciation, the 100% rate began decreasing by 20% annually starting in 2023, to its current rate of 40% in 2025, decreasing to 20% in 2026, and 0% thereafter.
In early April, the Senate made a crucial move towards extending the 2017 TCJA tax cuts, approving a budget blueprint with a 51-48 vote. More recently, on April 10, the U.S. House of Representatives passed a budget bill with a 216-214 vote. These plans aim to extend trillions of dollars' worth of tax cuts from the TCJA, and one of the key provisions set to be extended under this framework is 100% bonus depreciation.
If passed in its current form, this measure will enable entities to immediately deduct the full cost of eligible capital assets in the year they are placed in service, retroactive from Jan. 20, 2025. The extension of 100% bonus depreciation could, therefore, provide significant cash tax savings.
Let us look at an example:
A multi-tenant shopping center is acquired for $36 million in 2025. An appraisal is performed, and $7 million is determined to be attributable to the non-depreciable land, leaving the remaining $29 million as a depreciable basis. A cost segregation is performed on the acquired property after closing, resulting in:
| $29,000,000 – Depreciable Basis |
Proposed Tax Law 100% Bonus Depreciation |
Current Tax Law 40% Bonus Depreciation |
|---|---|---|
| 5-Year Personal Property | $6,750,000 | $6,750,000 |
| 15-Year Personal Property | 2,500,000 | 2,500,000 |
| 39-Year Real Property | 19,750,000 | 19,750,000 |
| First Year Bonus Depreciation (2025) | 9,250,000 | 3,700,000 |
| Total 2025 Depreciation (includes non-bonus-eligible depreciation) | 9,878,400 | 5,213,400 |
| Net Depreciation Adjustment (2025 depreciation difference between with a cost segregation and without) | 8,955,700 | 4,290,700 |
| 2025 Tax Savings (assuming 25.0 percent tax rate%) | $2,239,000 | $1,072,700 |
Not only can the taxpayer depreciate the five- and 15-year assets at an accelerated rate, but these asset classifications would qualify for the extended bonus depreciation at 100% as set forth in the proposed tax bill. Quantifying the benefit of the analysis using a 25% effective tax rate amounts to a recognized first-year benefit of $2.239 million. Under the existing tax law, with the 2025 bonus depreciation at 40%, this would amount to roughly half of the first-year benefit at $1.0727 million comparatively.
In summary, a cost segregation study without any bonus depreciation could provide significant cash tax savings, while the existing tax law provides an increased benefit through the bonus depreciation of 40% in 2025, and the proposed tax law would provide an even greater benefit with the extension of 100% bonus depreciation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
