Frequently Asked Questions

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The Internal Revenue Service (IRS) defines depreciation as a method of income tax deduction that allows companies to recover asset costs over time. Depreciation is the assessment of the decrease in the value of an asset due to continuous use over its useful life. The tax deductions received from depreciating the asset are called depreciation expenses. 

The IRS has designated guidelines indicating the assets that are eligible to be depreciated through certain means. For maximizing tax savings, it is beneficial to go with a higher depreciation rate in the initial years. This is especially true for the small businesses that can benefit from higher depreciation in the early years of ownership. 

For income tax purposes, property owners and real estate investors generally depreciate residential rental property over 27 ½ years and commercial property over 39 years. 

The purchased asset is not only the structure, but also includes other elements, such as plumbing fixtures, carpeting, sidewalks, fencing and more.

If you were to purchase these assets by themselves, you could depreciate them over five, seven or 15 years. But they are usually purchased as part of a building acquisition or development and written off over the same useful life as the rest of the building: 27 ½ or 39 years.

A cost segregation study is a process that looks at each element of a property, splits them into different categories, and allows you to benefit from an accelerated depreciation timeline for some of those building components.

With the Tax Cuts and Job Act (TCJA) of 2017, asset additions can qualify for 100% bonus depreciation in the year they are placed in service. This applies for new and used assets placed in service after September 27, 2017, and before January 1, 2023. Beginning in 2023, bonus depreciation phases out at 20% per year over the next five calendar years until 2027, unless Congress acts to extend it.

Cost segregation is a tax planning strategy that allows real estate investors to accelerate depreciation deductions by reclassifying certain components of their properties into shorter recovery periods. While cost segregation can provide significant tax benefits, it may not be a good idea for some investors due to various reasons:

1. Smaller-scale investors: Cost segregation studies can be costly and time-consuming. For smaller-scale investors with limited property holdings, the potential tax benefits may not outweigh the expenses associated with conducting the study.
2. Short holding period: If an investor plans to hold the property for a relatively short period, the upfront cost of a cost segregation study might not be justified by the limited time available to benefit from the accelerated depreciation deductions.
3. Low taxable income: Cost segregation primarily benefits investors with substantial taxable income. If an investor's taxable income is already low or if they have substantial tax deductions from other sources, the accelerated depreciation deductions may not be fully utilized.
4. Recapture upon sale: When the property is sold, the accelerated depreciation may result in higher depreciation recapture taxes. Depreciation recapture taxes are typically higher than the regular capital gains tax rates, potentially offsetting some of the initial tax benefits.
5. Passive loss limitations: Passive activity loss rules can limit the ability to deduct losses from passive real estate activities against other income. If an investor is subject to these limitations, the accelerated depreciation deductions from cost segregation might not provide immediate tax relief.

It is essential for investors to carefully consider their specific financial situation and consult with tax professionals before deciding on the appropriateness of cost segregation for their investments.