Is Cost Segregation Worth It?

If you own commercial or investment property, you may see significant tax savings with a cost segregation study. But is the expense of a cost segregation study worth it in the long run?

In this post, we’ll help you decide if a cost segregation study is worth investing in. By looking at the advantages and disadvantages–and giving you a practical example showing the benefits of accelerated and bonus depreciation–you’ll be in a better position to decide if cost segregation is the right tax strategy for your property.

Is Cost Segregation Worth It? The Short Answer

Is cost segregation worth it for your property? It depends. While many taxpayers will benefit greatly from cost segregation, this tax strategy isn’t a good fit for all property owners. This may be because the property doesn’t qualify for cost segregation, the drawbacks outweigh the benefits, or for other reasons.

Every property and tax situation is unique, so it’s up to the taxpayer to determine if cost segregation is worth the upfront costs in terms of time and expense. Fortunately, most reputable cost segregation companies offer a free feasibility analysis to determine if the property qualifies. These companies can always give you an estimate of tax benefits, and provide information about fees to complete the cost segregation study.

Do You Qualify For Cost Segregation?

Not all properties qualify for cost segregation. To qualify, you must have a property that meets any of these requirements:

• Commercial or investment property that was purchased
• Commercial or investment property that was built
• Commercial or investment property that has been remodeled or expanded

Cost segregation is only available for commercial or investment properties. This means that your primary residence is not eligible for cost segregation. Some second homes may be eligible provided you use the home for less than two weeks annually for personal use and the home is in a rental pool.

If you meet these requirements, cost segregation may be a good option. Contact a reputable cost segregation firm to receive a free feasibility analysis to see if your property meets the requirements and an estimate of how cost segregation can impact your tax return.

Weigh Out Cost Segregation Benefits & Drawbacks

If your property is eligible, the next step is to carefully weigh out the advantages and disadvantages of cost segregation.

There are several advantages of cost segregation, but they all boil down to one thing: more money in your pocket.

Following a cost segregation study, the accelerated depreciation of building components can significantly reduce your tax liability. Add in bonus depreciation for the first year, and the savings can be substantial. With look-back studies, you can retroactively claim depreciation, even if you purchased the property in previous years.

One thing to keep in mind is that cost segregation studies aren’t cheap. While the tax savings are often well worth this upfront investment, potential costs of $3,000 to $15,000+ may be a limiting factor if your business is having financial difficulties.

It is important to remember that this fee applies if you opt to move forward with the study. Most cost segregation companies will perform an initial analysis to determine if you qualify at no cost.

There’s also a chance that you may be audited by the IRS after filing your return with depreciation expenses. If you work with a reputable cost segregation company, you shouldn’t have anything to worry about (and some companies offer audit support).

If you sell your property or a building component, you also risk recapture of depreciation, which could increase your tax bill.

As you can see, there are several benefits and drawbacks of cost segregation. When weighing out your options, keep in mind things like:

• Your budget (Can you afford a cost segregation study?)
• Your time (Do you have time to gather the required documentation when requested?)
• Your future plans (Do you plan on selling your property or components in the near future, which could result in recapture of depreciation?)

Remember, you don’t have to figure it out alone. Speaking with a cost segregation company can help you answer these questions to determine if this tax strategy is right for you.

Cost Segregation Study Costs VS Cost Segregation Tax Benefits

If the expense of a cost segregation study has you on the fence, it helps to look at the numbers. By understanding how cost segregation works (and the benefits that come with it), it’s easy to determine if cost segregation is worth it — and in most cases, it is.

Let’s break this down with an example:

• Total Property Value: $800,000
• Land Value: $100,000
• Building Value: $700,000

In this example, let’s say you have a commercial property valued at $800,000. The value of the land is $100,000. Since land is not a depreciable asset, the building valued at $700,000 will be depreciated using the standard 39 years for commercial property.

By dividing the value of the building ($700,000) by the standard depreciation schedule (39 years), you can write off $17,949 in depreciation expenses each year. Not too shabby — until cost segregation comes into play.

For the purposes of this example, let’s assume you invest $10,000 into a cost segregation study. The study finds the following:

• $100,000 in components that can be depreciated over five years
• $50,000 in components that can be depreciated over 10 years
• $50,000 in components that can be depreciated over 15 years

The remaining value of the building ($500,000) will remain on the standard 39-year depreciation schedule. This will add an additional $12,821 per year.

By doing some quick division, we can determine that your annual write-offs in this scenario would be:

• $20,000 for components that depreciate over five years
• $5,000 for components that depreciate over 10 years
• $3,333 for components that depreciate over 15 years

Add these together and you will see that you can write off $28,333 in depreciation expenses. Don’t forget to add the standard depreciation ($12,821). All-in, this adds up to $41,154 — a difference of $23,205 compared to the standard depreciation schedule. The cost segregation study, which cost $10,000, has already more than paid for itself.

But wait — what if you decide to take advantage of bonus depreciation? In 2023, the bonus depreciation rate is 80%, meaning you can write off 80% of costs in the first year (this rate will decrease as bonus depreciation is phased out through January 1, 2027, unless new legislation is passed).

If all $200,000 in components that qualify for accelerated depreciation also qualify for bonus depreciation, we can multiply this number by 80% to calculate bonus depreciation for the first year. In this example, you could write off $160,000 in the first year.

As you can see, tax benefits can be quite significant even with this modest example. Since this is just an example, you should reach out to a qualified cost segregation team with some basic information to get an estimate of your tax benefits through cost segregation.

Bottom Line: Is Cost Segregation Worth It For Your Property?

Every tax situation is unique, so whether cost segregation is the right strategy for you will vary based on a number of different factors. By determining if you qualify, weighing out the pros and cons, and doing some quick calculations, you can determine if you’re ready to move forward with cost segregation and the accelerated depreciation that comes with it. After that, you can research the best cost segregation companies to help you with your next steps.

It also can’t be stressed enough that you should take advantage of a feasibility analysis. This takes the guesswork out of determining whether your property qualifies while providing you with an estimate of your tax savings. This analysis shouldn’t cost a dime and can help you determine if a cost segregation study is worth it for your property.