How to Maximize the Benefits of Cost Segregation and Bonus Depreciation

Feb 3, 2023

2 min read

What is Cost Segregation? Ask Ray Martin

Cost segregation is a study that is performed by an engineer. The engineer evaluates the components of the building and assigns a different tax life to each of the components.

So instead of broadly depreciating our four-plex over 27.5 years, they separate each of the building components into different tax lives. Depreciable assets are divided into 5, 7, 15, or 27.5 years. How they’re separated depends on the life of the component.

Broadly, anything structural has a 27.5-year life.

The non-structural components have a 5, 7, or 15-year life. Items like appliances or carpets take 5 years to depreciate. Land improvements, like fencing, are depreciated over 15 years.

The cost is spread out over a much shorter time period (5-15 years instead of 27.5 or 39 years). Therefore, the amount of your depreciation expense goes up significantly in the first few years of your ownership of the property.

This is called accelerated depreciation.

What is Bonus Depreciation?

Bonus depreciation adds another very significant benefit on top of accelerated depreciation.

We think of it as a turbocharged version of accelerated depreciation.

Bonus depreciation isn’t a new concept. However, it’s something that got better for real estate investors with the 2017 Tax Cuts and Jobs Act (TCJA).

Bonus depreciation allows you to take the components that have a 5-15 year lifespan and expense it all in one year instead of spreading it out.

For properties purchased prior to September 27, 2017, you could take 50% of this cost-segregated amount and expense it in Year 1. With the new law, for properties purchased after September 27, 2017, you can take 100% of the cost segregated components as a depreciation expense in Year 1.

So for our example property, instead of a depreciation expense of $14,545, with bonus depreciation, our depreciation expense in the first year went up to $125,000!

When added to the other rental expenses, our expenses now far exceed rental revenue (on paper). Therefore, the property will show a significant loss. However, these losses can be used to offset income from other sources.