How Cost Segregation Transformed My Real Estate Investments with Unmatched Tax Savings
Written by Jason Malabute, CPA
When I first started as a CPA, I had heard about cost segregation, but it wasn’t until I became a real estate investor and completed a cost segregation study on one of our own deals that I truly understood its power. While we hired a specialist to conduct the study, seeing the results firsthand opened my eyes to the incredible impact it had on our investment returns. The accelerated depreciation allowed through this process, especially with the bonus depreciation benefits, proved to be a game-changer for us and our investors, showcasing just how transformative cost segregation can be in real estate.
The Tax Cuts and Jobs Act (TCJA), signed into law in December 2017 under President Donald Trump, marked a significant shift in the U.S. tax system, with the goal of promoting economic expansion, job creation, and increased business investment. One of the most important changes introduced by the TCJA was a major reduction in the corporate tax rate, which was lowered from 35% to 21%. This reduction aimed to enhance the global competitiveness of American companies. For individual taxpayers, the TCJA kept the existing seven tax brackets but lowered rates across most of them, with the highest rate dropping from 39.6% to 37%. It also nearly doubled the standard deduction, making it more favorable for many taxpayers, while eliminating the personal exemption. The law further increased the child tax credit to $2,000 per child and temporarily raised the estate tax exemption to $13.6 million for single filers by 2024.
On the business front, the TCJA brought significant changes to how depreciation is handled, encouraging investment in capital assets. One of the most impactful changes was the introduction of 100% bonus depreciation, which allowed businesses to immediately deduct the full cost of qualifying assets, such as machinery and equipment, placed in service after September 27, 2017, and before January 1, 2023. Instead of spreading depreciation over several years, businesses could now take the full deduction in the year the asset was placed into service, reducing their taxable income considerably. This bonus depreciation will begin to phase out after 2022 and will completely expire by 2027. Additionally, the TCJA raised the Section 179 expensing limit to $1 million, with the phase-out threshold set at $2.5 million. Section 179 was also expanded to cover a wider range of improvements to nonresidential real estate, such as HVAC systems and roofs.
These changes to depreciation rules have been particularly beneficial for businesses making significant investments in capital assets, as they allow for faster tax write-offs and encourage expansion. However, since the provisions, particularly for bonus depreciation, are temporary and set to phase out, businesses are motivated to take advantage of these benefits while they last. The long-term effects of the TCJA are still unfolding, but its immediate impact on business investment and tax strategy has been substantial, particularly in industries that rely heavily on capital expenditures like manufacturing and real estate.
So, how does cost segregation actually work? Simply put, it helps real estate investors reduce their taxable income by speeding up depreciation. Instead of waiting for the standard 27.5-year or 39-year depreciation schedules, cost segregation breaks down the property into different components like personal property or land improvements, which have shorter depreciation periods (think 5 to 15 years). This allows you to claim larger depreciation amounts in year one to offset more taxable income.
For example, in one of our recent deals, we purchased a property for $13.4 million. After separating out the land, which was valued at $2.68 million (and non-depreciable), we had about $10.7 million in depreciable assets. Now, without cost segregation, we would have been limited to a depreciation claim of only $146,000. However, by conducting a cost segregation study, we identified parts of the property that could be depreciated much faster—specifically, $2.57 million in 5-year property, $536,000 in 15-year property, and the remaining $7.61 million in 27.5-year property.
The real benefit here is bonus depreciation, which allows us to take 80% of the depreciation in the first year for assets with a useful life of 20 years or less. Thanks to this, instead of spreading that depreciation out over many years, we were able to claim $2.7 million in depreciation upfront, massively reducing our taxable income.
It’s important to note that bonus depreciation is being phased out gradually. After December 31, 2022, the amount of bonus depreciation you can claim decreases by 20% each year—so in 2023, it’s 80%, in 2024 it drops to 60%, and by 2027, it will be fully phased out. This is why it’s so crucial to do a cost segregation analysis as soon as possible if you plan on purchasing property in the coming years. Taking advantage of these tax benefits while they’re still available can make a significant difference in your investment returns.
Ultimately, cost segregation, when paired with bonus depreciation, is a powerful strategy for real estate investors looking to maximize tax savings. It’s a tool that I’ve personally found invaluable, and I encourage every investor to explore how it can work for them.
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Jason has been in the accounting industry since 2013. Over the years, he has honed his skills in tax preparation, tax planning, accounting, and payroll services, specifically working with high-net-worth individuals involved in real estate. His extensive experience has equipped him to address the unique financial needs and challenges that come with real estate investments. On the real estate side, Jason is not just an accountant but also an active investor. Since 2019, he has built a diverse portfolio that includes out-of-state rental properties, single-family homes, and large multi-family deals. He has successfully implemented buy-and-hold and BRRRR strategies and currently serves as a general partner on two multi-family syndication deals totaling 342 units. His combined expertise in accounting and real estate investment allows him to offer unparalleled insights and services to his clients.
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