If your clients own a business building or residential rental property, you’re likely familiar with the standard depreciation periods—typically 39 years for business buildings and 27.5 years for residential rentals. However, what if we told you that many “parts of your building” could be depreciated much, much faster, potentially leading to significant tax savings? This is where real estate cost segregation comes into play, and recent changes to bonus depreciation and the Section 179 deduction have made it even more powerful.
What is Cost Segregation?
Cost segregation is an engineering-based study that identifies and reclassifies various building components and improvements that are normally considered part of the real property. The goal is to separate these components from the building’s overall structure so they can be depreciated over shorter periods, rather than the lengthy 39 or 27.5 years.
For instance, consider your building’s electrical system. While it seems like an intrinsic part of the building, the costs allocable to running your business equipment within that building could potentially be depreciated over a five- or seven-year period. This is a dramatic difference from 39 years!
The Impact of New Depreciation Rules
Now, let’s look at how recent tax law changes amplify the benefits of cost segregation:
Bonus Depreciation
The rules around bonus depreciation have seen significant shifts that are highly favorable for real estate owners. Under the Tax Cuts and Jobs Act, bonus depreciation has been phasing out 20% per year for the past few years, with the ultimate end at 0%. This was a source of much distress for many taxpayers. OB3 brings back 100% bonus, but with a few caveats.
- 100% Bonus Depreciation: For property acquired after January 19, 2025, bonus depreciation is increased to 100%, meaning you can potentially write off the full cost of qualifying property in the year it’s placed in service.
- Acquisition Date Matters: It’s important to note that for the 2025 taxable year, eligibility for 100% bonus depreciation looks to the property acquisition date, not the date it’s placed in service.
- Exceptions: If you entered into a written binding agreement to purchase qualifying depreciable property prior to January 19, 2025, you generally won’t be eligible for the 100% bonus when the property is placed into service. In such cases, you would typically use 40% bonus depreciation, the IRC §179 expensing, or standard MACRS depreciation.
- Transition Rules: For property placed in service during the first taxable year ending after January 19, 2025, taxpayers can elect to apply bonus depreciation percentage at 40%. For certain aircraft and property with a longer production period under specific IRC sections, this election amount is 60%.
How this benefits cost segregation: Imagine those electrical system costs that could be depreciated over five or seven years. With 100% bonus depreciation, these costs (and many other identified components) could potentially be completely written off in the year they are placed in service! This provides an immediate and substantial reduction in taxable income.
Section 179 Deduction
The §179 Deduction also offers an immediate expensing opportunity and has seen its limits permanently increased:
- Increased Expensing Limit: The OB3 Act has permanently raised the maximum amount a taxpayer may expense under §179 to $2.5 million for 2025 and all future taxable years.
- Phase-Out Threshold: This maximum amount is reduced by the amount by which the cost of qualifying property exceeds $4 million.
- Inflation Adjustment: Both the $2.5 million limit and the $4 million threshold will be adjusted for inflation in future tax years.
- Effective Date: These changes apply to tax years beginning after December 31, 2024.
- Great alternative for property acquired on or before January 19, 2025. Because the §179 expensing is applicable for property acquired after December 31, 2024, it provides the perfect alternative to bonus for property acquired before January 20, 2025.
How this benefits cost segregation: Like bonus depreciation, the increased §179 deduction allows you to immediately expense the cost of many assets identified through a cost segregation study, up to the specified limits. This means more of your building’s “hidden” components can be written off in the first year, providing significant upfront tax relief.
With the return of 100% bonus depreciation and expanded Section 179 limits, cost segregation has become an even more powerful tool in the tax preparer’s arsenal. If you work with clients who own commercial buildings or rental properties, now is the time to revisit their depreciation strategy. Identifying assets that qualify for accelerated write-offs could mean thousands in immediate tax savings—and a chance to deliver real, measurable value.
Looking for more real estate strategies, including cost segregation studies? Check out our upcoming Tax Toolbox Seminar.