Why do investors use it?

Faster depreciation means bigger deductions now and lower taxes in the early years.

What is depreciation recapture?

When you sell, the depreciation you took is taxed. On commercial buildings the “unrecaptured §1250” portion is taxed at up to 25%.

How is recapture different on cost-segregated parts?

Shorter-life personal property is generally recaptured at ordinary income rates.

How can recapture be deferred?

A properly structured 1031 exchange defers recapture along with the capital gain.

Cost segregation moves 25% of a $3,750,000 building into 5–15 year property. How much is reclassified?

$937,500, which can be deducted far faster than 39 years.

The remaining $2,812,500 on 39 years. Annual depreciation?

About $72,100 a year, plus the faster write-offs on the $937,500.

CRE Glossary

Cost Segregation: The Highest-ROI Tax Strategy in CRE

An IRS-sanctioned study that converts ordinary depreciation into accelerated depreciation — often returning 8–10x on the study fee in year one.

How It Works

A qualified engineer walks the property and reclassifies basis components by useful life. Carpet, electrical, decorative finishes → 5 or 7-year property. Site improvements (parking, fencing, landscaping) → 15-year property. The remaining building shell stays at 39-year. Any asset with ≤20-year recovery is eligible for bonus depreciation in year one.

The Math Example

$5MM building, $1MM (20%) reclassified, 40% bonus depreciation = $400K year-1 acceleration. At 37% marginal federal rate = ~$148K of cash tax savings. Study fee: ~$15K. ROI: 9–10x.

The Recapture Catch

Accelerated depreciation is recaptured at ordinary rates on sale (up to 37%) — not the 25% Section 1250 rate. The net benefit is timing, not permanent. But timing in CRE compounds: the tax savings fund the next acquisition, which generates more savings.

Bonus Depreciation Phase-Down

2022: 100%
2023: 80%
2024: 60%
2025: 40%
2026: 20%
2027: 0% (unless extended)

Estimate Your Cost Seg Savings

Input purchase price, bracket, and reclass % — see your year-1 tax savings and study fee ROI.

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Cost Segregation and Recapture Flash Cards

Study mode · 10 flash cards

Cost Segregation and Recapture Flash Cards

10 cards: depreciation, cost segregation and recapture, then worked examples. Study full screen and mark what you know.

The concept 5Work the numbers 5

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All 10 flash cards as text

The concept

What is cost segregation?: An engineering study that splits a building’s cost into shorter-life parts (5, 7 and 15 years) so they depreciate faster than the 39-year building.
Why do investors use it?: Faster depreciation means bigger deductions now and lower taxes in the early years.
What is depreciation recapture?: When you sell, the depreciation you took is taxed. On commercial buildings the “unrecaptured §1250” portion is taxed at up to 25%.
How is recapture different on cost-segregated parts?: Shorter-life personal property is generally recaptured at ordinary income rates.
How can recapture be deferred?: A properly structured 1031 exchange defers recapture along with the capital gain.

Work the numbers

A building (excluding land) costs $2,400,000. Annual straight-line depreciation over 39 years?: About $61,500.
After 10 years, total depreciation?: About $615,000.
At a 25% maximum rate, tax on that recapture?: Up to about $154,000.
Cost segregation moves 25% of a $3,750,000 building into 5–15 year property. How much is reclassified?: $937,500, which can be deducted far faster than 39 years.
The remaining $2,812,500 on 39 years. Annual depreciation?: About $72,100 a year, plus the faster write-offs on the $937,500.

Frequently Asked Questions

What is cost segregation?

Cost segregation is an IRS-sanctioned engineering study that reclassifies portions of a commercial building from 39-year straight-line depreciation into 5-year, 7-year, and 15-year recovery categories. Personal-property components (carpeting, decorative fixtures) go to 5–7yr; site improvements (parking, landscaping, lighting) go to 15yr.

How much can cost segregation save on taxes?

On a $5MM building with $1MM (20%) reclassified to short-recovery property, year-1 bonus depreciation can generate ~$400K of accelerated deduction. At a 37% federal marginal rate, that's ~$148K of cash tax savings — versus a typical $15K study fee. ROI is commonly 8–10x.

Is cost segregation legal?

Yes — explicitly endorsed by the IRS in the Audit Technique Guide for Cost Segregation. The requirement is an engineering-based study by a qualified provider, not a back-of-envelope estimate.

What is the catch?

Accelerated depreciation is recaptured at ordinary income rates on sale (up to 37%), not the 25% Section 1250 rate. Net benefit is timing — but timing in CRE is extraordinarily valuable because the tax savings fund the next deal.

Are there Cost Segregation and Recapture flash cards?

Yes. This page has 10 flash cards: five on the concept and five worked examples, worked examples. Study them full screen or open the text version below the viewer.