Investors
How does bonus depreciation and cost segregation work?
By Steve Lockhart
The short answer
Depreciation is the tax concept that lets owners of income property deduct a portion of the building's cost each year, because a building wears out on paper even when it appreciates in value. Under the traditional rules, residential real estate is depreciated over a long schedule.
Full answer
Depreciation is the tax concept that lets owners of income property deduct a portion of the building's cost each year, because a building wears out on paper even when it appreciates in value. Under the traditional rules, residential real estate is depreciated over a long schedule. Cost segregation takes the purchase apart, a fixture here, an appliance there, and assigns shorter useful lives to components that qualify, which is what lets more of the cost be depreciated sooner. Bonus depreciation then allows an upfront deduction on eligible assets in the year the property is placed in service.
Investors look at both because of timing. Accelerating deductions moves tax savings into the early years, when a property is often spending heavily on purchase costs, repairs, and leasing. Faster deductions can mean better near-term cash flow and a lower tax bill in the years that matter most to the deal. But the details are numerous: what qualifies, what percentage applies in a given year, how partial-year rules work, and how the deductions interact with your other income, your entity, and a future sale. Those rules have changed before and can change again.
I am not a tax advisor, and I will not pretend to be one. Cost segregation studies have a cost, and whether the acceleration makes sense depends on your income, your holding plan, and your whole tax picture. The responsible move is to have a qualified CPA or tax professional who works with real estate model your specific situation before you structure the deal or file the return, and to keep the depreciation schedule and records they prepare. I can help you underwrite the property and build the professional team; the tax call belongs to your tax professional.
A note from Steve: nothing on this page is investment, legal, or tax advice. Markets move, and every property is different. Run your own numbers on the specific deal, and talk to your CPA and attorney before you commit.
Go a little deeper
Frequently asked
Questions investors often follow up on
Is cost segregation worth it for a single rental?
It can be, but the study costs money and the benefit depends on the property value, what is in it, and your tax situation. A qualified tax professional can estimate the potential benefit before you pay for the study, which is the honest way to decide.
Does bonus depreciation apply every year?
No. The percentage and eligibility have changed under successive tax laws, and future rules may differ from the current ones. That is exactly why the rules for the year you buy should be confirmed with a tax professional rather than assumed from an article.
What happens to the depreciation when I sell?
Depreciation taken reduces your tax basis, which affects the gain when you sell, and some of it is recaptured and taxed at that point. A qualifying 1031 exchange can defer the gain, which is why the sale plan and the tax plan should be built together before you act.
The Lockhart Method
The Lockhart Method
Your Home | My Strategy | Proven Results
My strategy: the tax plan gets set before the offer, not after the closing. We put the cost segregation and depreciation questions on the table early, bring in a CPA who works with investors, and make sure the deal's numbers reflect the tax treatment you can actually claim.
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