Accelerate ROI: Harnessing the Benefits of Cost Segregation

Discover how cost segregation studies can maximize tax benefits and unlock hidden value in real estate investments. Learn about the process, benefits, and examples of cost segregation studies in this blog post.

Discover how cost segregation studies can maximize tax benefits and unlock hidden value in real estate investments. Learn about the process, benefits, and examples of cost segregation studies in this blog post.

What is Cost Segregation?

Cost segregation is a strategic tax planning tool used by real estate investors and their CPAs to accelerate depreciation deductions on commercial properties (including residential rentals).

By identifying and reclassifying assets within a property from real property to land improvements and personal property, cost segregation studies allow a shorter depreciation recovery period for those “segregated” assets. This can result in significant tax savings for the investors/property owner in the near term.

Traditional real property depreciation typically spans either 27.5 years, for residential rentals, or 39 years for all other commercial properties. By employing a cost segregation study, however, assets can be reclassified to shorter recovery periods, for example, 5, 7, or 15 years, and that’s before any bonus is taken.

From September 2017 to the end of 2022, for instance, bonus rules allow all assets built or bought during that time period, and being depreciated under recovery periods of 20 years or less, to take 100% depreciation in the first year. This means that the sum total of 5,7, 15 or any other recovery period identified in a cost seg can be deducted as an expense in year one.

Considering that Cost Seg studies are often identifying as much as 40% (sometimes more) of property assets (by value) into recovery periods that are 20 years or less, the tax savings can be incredibly substantial.

The Benefits of Cost Segregation Studies

Cost segregation studies offer several compelling benefits for real estate investors.

As outlined above, they provide immediate tax savings by front-loading depreciation deductions, resulting in substantial reductions in taxable income (especially when bonus applies). By doing this, investors are freeing up additional cash flow to be reinvested or used for other business purposes.

Furthermore, cost segregation studies, when implemented at the strategy level, can improve metrics on investment properties, e.g. by increasing after-tax income, making some deals more lucrative/attractive than they otherwise would be.

How Does a Cost Segregation Study Work?

Cost segregation studies are detailed analyses of a property’s components and associated costs.

The studies identify assets which qualify for shorter depreciation recovery periods by analyzing them in reference to IRS regulatory publications, established case law, and industry best practices.

These comprehensive studies provide a thorough breakdown of the costs associated with all segregated assets, allowing for precise reclassification and optimization of tax benefits.

Real-Life Examples of Cost Segregation Studies

To better understand the impact of cost segregation studies, let’s consider an example.

Suppose a business owner purchases a commercial property for $1 million. They expect to depreciate the entire amount over 39 years. However, through a cost segregation study, it is determined that $250,000 of the property’s value can be reclassified as a shorter-life asset. These shorter-life assets are eligible for recovery periods much shorter than the long-life recovery period, for instance: 3,5,7, and 15-year depreciation recovery periods.

Depending on the specific reclassification results, this can result in significant tax deductions and increased free cash flow over the long term.

Cost Segregation Services: Hiring the Experts

While the concept of cost segregation may seem straightforward, conducting a thorough and accurate study requires specialized expertise.

Hiring a professional cost segregation service ensures the study is conducted in compliance with the latest tax regulations to provide the maximum tax benefits. These services have a deep understanding of cost segregation methodologies and can navigate the complexities of the process, ensuring a comprehensive analysis tailored to your specific property.

This results in optimal study results that are robust to IRS audit.

Making Informed Decisions with Cost Segregation Studies

By conducting a cost segregation study, real estate investors gain valuable insights into the financial impact of their property. These studies provide a detailed breakdown of asset costs, allowing investors to make informed decisions regarding asset management, refinancing, and even future acquisitions.

With a clear understanding of the components and their associated values, investors can optimize their tax strategies and enhance their overall investment performance.


Cost segregation studies are a powerful tool for real estate investors and business owners seeking to unlock hidden value and reduce tax liability. By accelerating depreciation deductions, these studies provide immediate tax savings, enhance cash flow, and maximize return on investment. 

To fully harness the benefits of cost segregation, it is advisable to engage a professional cost segregation service with the expertise and technology to conduct the highest level quality studies. 

Complete Your Cost Segregation Studies Today

SegStream is a simple and easy-to-use software solution that helps CPAs, specialty tax firms and tax experts grow their businesses by completing more cost segregation studies in less time.

Created by a team of architects, engineers, and Cost Seg professionals, SegStream provides IRS audit-proof cost segregation studies in hours NOT days.

With SegStream, you can complete cost seg studies with no previous cost segregation experience but if you consider yourself a pro, SegStream will turbo-charge your study production efficiency.

Schedule a demo today and learn how SegStream can help you grow your business.

How to Conduct a Quality Cost Segregation Study

In our last post, we explained what a cost segregation study is as well as the benefits a cost segregation can provide the taxpayer.

In this post, we’ll focus more on how to conduct a quality cost segregation study and the steps involved in the process.

Cost Segregation Study Methodology and Best Practices

Cost segregation studies do not significantly increase the likelihood a property will come under audit; however, should they come under audit, and the study was conducted poorly or improperly, the taxpayer could be liable for penalties and recapture. The bottom line is that the segregation of property into Section 1245 and Section 1250 assets must not only be worth the time, effort, and money involved in the process but they also must be worth the risk. Sound Cost Segregation methodology can virtually eliminate this risk.

While there is no prescribed framework for conducting a cost segregation study, the following steps can help to ensure a quality cost segregation study:

1.  Cost/Benefit Analysis

Before you decide to conduct a study, sit with your CPA and crunch the numbers. Pour through your depreciation schedules, identify any gaps in your documentation, and evaluate the deprecation benefit against your future business plans to determine whether the investment is beneficial in the long term. For example, if your business involves the regular purchase and resale of real estate, your CPA can help you decide whether or not depreciation recapture will negate the benefits of cost segregation. That being said, even in the case of recapture, the present day cash value of the benefit as an interest-free loan from the government could easily be sufficient enough benefit to conduct a study.

A pre-study cost-benefit analysis can shed light on the pros and cons of conducting a cost segregation study on the property in question.

2.  Hire an Expert

Cost Segregation Studies require extensive engineering analysis of real estate assets. Detailed knowledge of various building types and their corresponding components is prerequisite for a quality Cost Segregation preparer. Studies conducted by a structural, construction, or any type of engineer really should be viewed as much more reliable than those conducted by a non-engineer. And if the preparer is also knowledgeable about tax law, cost estimation, and value allocation all the better.

Preparers should be an expert in the field of cost segregation analysis and have the credentials and references to prove that expertise.

3.  Organize your Documentation

Quality Cost Segregation studies require a rigorous allocation of costs amongst the various asset categories to achieve optimal results. Preparers should know how to treat (or estimate in the case of used property) all direct and indirect costs associated with a property but should also be able to justify this treatment to all concerned parties, including the IRS in an audit. The preparer should have extensive access to all property-related documentation. Prepare all documentation for immediate reference before the preparer begins.

Helpful Documentation:
  • Official payment documentation such as Project Budgets and Contractor’s Applications for Payment with the underlying invoices from subcontractors for new construction projects
  • Construction drawings and documentation such as ALTA surveys and municipal permits for new construction projects
  • Closing statements, appraisals, existing drawings, ALTA surveys, and rent rolls are invaluable for acquisition projects

Sometimes, especially in the case of an acquisition, documents are missing or unavailable. In such cases, the taxpayer should do their best to furnish whatever documentation is available and answer all of the preparer’s questions as accurately as possible.

Comprehensive documentation helps the preparer in identifying/classifying assets and allocating costs accurately.

4.  Site Visit

The preparer should visit the property to truly understand and document the project design as well as to understand the purpose and uses of specific assets. A detailed study of specific asset uses will help determine if any particular asset should be classified as personal property, qualified improvement property, or if it should remain long life property. For instance, if a portion of the building’s electrical conduit and wiring is specifically run to power qualified equipment, for example office cubicles, then that portion of the electrical conduit and wiring can be classified as personal property. The preparer should then document the equipment, the cubicles in this case, and the electrical connections with notes and photos as evidence for why the conduit and wire associated with these electrical connections is considered personal property. The preparer will also review the structure’s conformity with construction drawings and other documents, as well as conduct interviews with ownership, contractors, or other vendors who may be on site.

In the case of acquired properties, the preparer should collect photographic evidence of all substantial property as well as any physical deterioration or functional obsolescence of assets and account for the same while estimating the value of these assets.

5.  Report Preparation

After the site visit, the Cost Segregation team will begin the process of preparing the Cost Segregation report. They will review all the documents extensively, verify the assets, compare them or estimate their value with quality cost data (e.g. RSMeans), and segregate assets according to their appropriate recovery periods.

The report should then be reviewed to ensure that it aligns well with the formulae laid out in the IRS Cost Segregation Audit Technique Guide [1]. Once the report has been reviewed and finalized, the CPA will extract the pertinent data and apply it to the client tax return. Depending on when the property was placed in service, there may be other considerations for the accounting professional, e.g. filing a change in accounting method (form 3115) for properties placed in service in prior years, step-up in basis due to inheritance or partial ownership changes, or 1031 exchanges, etc.

Cost Segregation Study – Best Practices

A successful Cost Segregation study should maximize tax savings and cash flow but also conform to best practices so that the benefit gained will be strongly protected in the case of an audit. The preparer should ensure that the cost segregation report is comprehensive and accurate and that it conforms to the highest standards set out in the IRS ATG.

A successful Cost Segregation study should maximize tax savings and cash flow but also conform to best practices so that the benefit gained will be strongly protected in the case of an audit. The preparer should ensure that the cost segregation report is comprehensive and accurate and that it conforms to the highest standards set out in the IRS ATG.

  1. The IRS describes a quality Cost Segregation study [2] as having the following elements:
  2. Description of the study methodology and listing of the steps taken to classify assets and determine costs.
  3. Use of common nomenclature to describe individual property items and standard numbering system to facilitate property classification.
  4. A legal analysis, including relevant citations, to support Section 1245 property classifications.
  5. Documentation of unit costs determination methodology (Engineering “take-offs”)
  6. Asset grouping and identification and listing of assets reclassified as Section 1245 property
  7. Explanation of the Indirect Cost treatment, and reconciliation of total allocated costs to total actual costs, and
  8. Consideration of related issues such as Section 263A [3], changes in accounting methods, and sampling techniques.




What is a Cost Segregation Study?

Adding to the bottom line is the ultimate goal of every business. There are, of course, a multitude of methods a business can employ to achieve this goal. If you hold commercial real estate, a Cost Segregation Study might just be the method for you!

What exactly is a Cost Segregation Study?

Simply put, a Cost Segregation Study enables you to reallocate part of the cost basis of a purchased or newly constructed commercial property into multiple asset classes, allowing for accelerated depreciation of a percentage of the property’s cost basis. This depreciation results in a deduction under the tax code, lowering your tax bill and boosting cash flows. The IRS suggests the following asset categories into which the asset cost basis can be allocated:

  • Personal Property
  • Land Improvements
  • Building
  • Land

How does Cost Segregation help?

“A bird in hand is worth two in the bush”

Front-loading your depreciation benefit will let you take advantage of the time value of money. By identifying personal property and land improvement components that would have otherwise have been lumped in with the total cost of the asset, a Cost Segregation study helps businesses depreciate their assets at an accelerated rate and, in some cases, even expense the accelerated property immediately. 

Personal property such as furniture, fixtures, equipment, some flooring types, etc., have relatively short depreciable lives (five years). On the other hand, the normal depreciable life of buildings and other real estate assets is 27.5 years (for residential real estate) and 39 years (for commercial non-residential real estate). By treating components as personal property and land improvements, your commercial property assets will be eligible for much shorter life spans. The shorter the depreciable life of the asset, the greater your depreciation deductions and greater tax savings.

Cost Segregation also allows you to take advantage of bonus depreciation for qualified assets in the first year in which the asset is put in service. The 2018 Tax Cuts and Jobs Act (TCJA), for instance, has increased the bonus depreciation available for 5, 7, and 15-year assets to 100% of the depreciable basis. By segregating your cost basis, you can take advantage of the bonus depreciation deduction available for personal property and qualified improvement property.

Furthermore, the TCJA has also introduced the “new to the taxpayer” concept wherein a taxpayer can claim bonus depreciation for even previously used properties so long as the owner has not had a previous depreciable interest in the property. In other words, if you purchase commercial real estate property from a third party, you can claim bonus depreciation in the first year in which you place the asset in use for your business. Your real estate asset need not be a new asset for you to claim bonus depreciation.

Let’s illustrate the benefits of a Cost Aggregation Study through an example

Tim is the owner of a multi-unit apartment complex, which he purchased in 2020 for $1.5 Million. He wants to record the depreciation costs for the 2020 tax year for his property. Other details are as below:

  • Land Value included in the Purchase Price of the Building = $500,000.00
  • Depreciable life of the Asset (apart from the land and per tax laws) = 27.5 Years
  • Marginal Tax Rate = 40%
  • Applicable Bonus Depreciation for the year 2020 = 100%
  • Depreciation Method followed for Long Life Property = Straight Line Method

Tim’s CPA calculates the depreciation for his property as follows:

Building Value (A) $1,500,000
Less: Land Value (B) $500,000
Depreciable Basis [C= (A-B)] $1,000,000
Depreciable Life of the property (D)
(Not Bonus Eligible!)
1st Year Depreciation Deduction [E= (C/D)] 
(Half-Year Convention for Convenience )
Marginal Tax Rate (F) 40%
*1st Year Cash Flow due to depreciation [G=(E*F)]1 $7,273
Example without Cost Segregation

Tim wonders if there is a better way to increase his tax savings due to depreciation and, in turn, increase free cash flow. His CPA suggests that Tim should explore the option of undertaking a Cost Segregation Study to save on his tax bills and increase cash flow. He also informs Tim that by segregating his acquisition cost, he can qualify for Bonus Depreciation on personal property and qualifying land improvements. Tim’s interest is piqued, and he hires a team of experts to conduct the study.

The team conducts the Cost Segregation Study and segregates the asset cost of $ 1.5 Million into the following asset categories:

Building Value (A) $1,500,000
Less: Land Value (B) $500,000
Depreciable Basis [C= (A-B)] $1,000,000
Personal Property / 5 Year Assets (D1)
12% of $1,000,000 (100% Bonus Eligible!)
Land Improvements / 15 Year Assets (D2)
17% of $1,000,000 (100% Bonus Eligible!)
Real Property (Building) / 27.5 Year Assets (D3)
71% of $1,000,000 (No Bonus & 1/2 Year Convention) 
1st Year Depreciation Deduction [E= (D1+D2+D3)] $302,909
Marginal Tax Rate (F) 40%
1st Year Cash Flow due to depreciation [G2=(E*F)]
With Cost Segregation
*1st Year Cash Flow due to depreciation [G1=(E*F)]
Without Cost Segregation (from Example Above)
1st Year Increased Cash Flow with Cost Segregation [GIncrease=G2-G1] $113,891
Example with Cost Segregation

Through the segregation of assets, the team found an increased depreciation deduction/tax savings of $302,909 and increased cash flow of $121,164 in the first year.

That’s an additional cash flow increase of $113,891 in the first year with a Cost Segregation!

Year 5-Year Assets 15- Year Assets 27.5-Year Asset Depn Dedn
With Cost Seg
Depn Dedn
Without Cost Seg
Inc Depn Dedn Inc Cash Flow @40%
1 $120k $170k $12,909 $302,909 $18,182 $284,727 $113,891
2 0 0 $25,818 $25,818 $36,364 ($10,545) ($4,218)
3 0 0 $25,818 $25,818 $36,364 ($10,545) ($4,218)
4 0 0 $25,818 $25,818 $36,364 ($10,545) ($4,218)
5 0 0 $25,818 $25,818 $36,364 ($10,545) ($4,218)
First Five Years of Depreciation

Cost-Benefit Analysis

Many small businesses shy away from conducting Cost Segregation studies as they believe it to be cost-prohibitive. The simple truth is Cost Segregation Studies come at a cost but can be economical even for properties with a basis of as small as $300,000! You can even write off the cost of the study itself, that’s a win-win!

Another common reason for hesitation is the fear of depreciation recapture on the sale of assets. Though you may end up showing the recapture as ordinary income when you sell your asset at a profit, remember that this will be taxed at the capital gains rate. In contrast, if you had not used a Cost Seg study to offset your ordinary income in the present, that income would have been taxed at your marginal tax rate (which is certainly higher than the Capital Gains rate).

4 IRS Endorsed Ways to Audit-Proof Cost Seg Reports

Do you struggle with multiple software applications, a pile of client documents, and a jumble of takeoff notes to put your cost segregation reports together?

Performing a cost segregation study is inherently complex and convoluted: every job has it’s own eccentricities which must be considered to make sure that a client’s cash-flow strategy is built on a solid foundation.

So how do you go about standardizing your cost segregation workflow to reduce redundancy, enhance precision, increase efficiency, and create high quality reports consistently and at a speed that not only sustains but grows your business?

Let’s start by establishing what makes a report high quality? According to the Audit Techniques Guide we have:

  • Engineering-based, Detailed Takeoff
  • Suggested Data Sources
  • Clear and Transparent Labeling/Numbering System for Takeoff
  • Clear Reasoning for Segregation of Personal/Real Property into Respective Depreciable Asset Classifications

How do you include these elements into your reports, consistently and efficiently?

Let’s take each element separately,

Engineering-based, Detailed Takeoff:

Properly document the property on-site, draw information from client interviews, property photos, and relevant data sources on the internet like GIS Maps and Google Earth.

Suggested Data Sources:

The IRS Audit Techniques Guide explicitly mentions two cost sources, RS Means and Marshall & Swift. Of the two, RS Means is by far the most complete.

Clear and Transparent Labeling/Numbering System for Takeoff:

Labeling and numbering of takeoffs to help illuminate your choice of asset classification within the report.

Clear Reasoning for Segregation of Personal/Real Property into the Respective Depreciable Asset Classifications:

The special sauce of any cost segregation report, what gets qualified, what doesn’t, why, and what is the recommended depreciable life of each asset according to the relevant depreciation method?

Now that we’ve outlined the significance of each element, let’s take a look at what kind of system can efficiently and precisely receive the detail of the engineering-based takeoff method, is set up to use the IRS Audit Techniques Guide recommended data sources, includes a transparent labeling/numbering system, and implements clear reasoning for asset segregation/qualification.

How can you increase precision, efficiency, quality, and speed simultaneously? In a nutshell, custom software.

Every Cost Seg provider is currently using some type(s) of software to complete their projects but in order to include all of the benefits discussed above, the software solution needs to address the needs of the cost segregation professional directly.

Custom-designed software for the Cost Segregation professional has traditionally been hard to come by, until now.

The SegStream Cost Seg workflow was built to complement the knowledge of accounting and specialty tax professionals, eliminating trade-offs between quality and consistency, and precision and velocity.

SegStream brings the Cost Seg workflow into a single piece of software, where everything from takeoff to data entry to report generation can be optimized, continuously and rapidly.

The entire business world is being eaten by software and Cost Segregation will not be spared. This is a new world, in which custom software is the driving force of quality and business innovation in every industry, and your business can’t afford to get left behind.

SegStream is the first software developed by Cost Segregation engineers for accounting and specialty tax professionals. Read further if you’d like to know more or Contact Us for a demonstration of how SegStream can increase everything from your employee morale to your profit margin.