Tax planning for real estate investments has always been complex, but one strategy remains essential in 2024: cost segregation. This powerful tool accelerates depreciation, providing real estate owners significant tax savings upfront. In this post, we'll explore the 2024 outlook on cost segregation, how it impacts real estate investments, and why timing your cost segregation study is more important than ever.
A cost segregation study is a detailed analysis that breaks down the components of a property into different categories for tax purposes. Instead of depreciating the entire building over a standard 27.5 years (for residential properties) or 39 years (for commercial properties), certain parts of the building—like furniture, fixtures, and land improvements—can be depreciated over shorter periods of 5, 7, or 15 years. By front-loading depreciation, property owners can significantly reduce their taxable income in the early years of ownership, boosting cash flow and improving investment returns.
For example, if you purchase a commercial property for $5 million, a cost segregation study might allow you to reclassify $500,000 of assets as 5-year property, $250,000 as 7-year property, and $750,000 as 15-year property. This reclassification can lead to an immediate increase in depreciation deductions, enhancing your tax savings dramatically compared to a standard depreciation schedule.
One of the most critical factors influencing cost segregation strategies in 2024 is the ongoing phase-out of bonus depreciation. In 2023, taxpayers could deduct 80% of qualified property costs in the first year. However, this amount has decreased to 60% in 2024, and it will continue to phase out entirely by 2026.
Bonus depreciation applies to depreciable assets with a useful life of 20 years or less, making it a crucial tool for cost segregation. As it continues to phase out, maximizing the benefits of bonus depreciation in 2024 through a well-timed cost segregation study is more important than ever. By front-loading deductions, you can shield more of your income from taxes, which is especially useful given rising interest rates and higher real estate costs.
For real estate investors, a cost segregation real estate strategy isn't just about tax savings—it's about improving cash flow. By accelerating depreciation, investors can reinvest their savings into new properties, make improvements, or simply bolster their cash reserves during the critical early years of ownership.
The strategy is particularly useful for owners of large commercial properties or those with multiple residential units. High-cost improvements like parking lots, sidewalks, and security systems can be depreciated over shorter schedules, providing immediate financial relief. Even if you’ve already owned your property for several years, a "look-back" cost segregation study can unlock retroactive tax benefits through catch-up depreciation.
Conducting a cost segregation study typically involves hiring a specialized firm with engineering and tax expertise. The study includes an on-site review and analysis of architectural drawings, electrical plans, and mechanical systems. These components are then categorized into different depreciation schedules.
The average cost of a study ranges from $5,000 to $15,000 depending on the property size and complexity.
However, this upfront expense often pays for itself many times over in tax savings.
With the reduction of bonus depreciation, timing your cost segregation study has become a crucial strategic decision. In many cases, the best time to perform a study is immediately after acquiring or constructing a property. This allows investors to begin benefiting from accelerated depreciation right away, maximizing their cash flow during the critical early years of ownership.
That said, if you’ve owned a property for several years, don’t worry—look-back studies allow you to claim missed depreciation in a single tax year, providing a substantial "catch-up" deduction.
As the 100% bonus depreciation introduced by the Tax Cuts and Jobs Act continues to phase out, strategic planning becomes even more critical. Real estate owners must adjust their cost segregation strategies to account for this reduction, identifying other opportunities to accelerate depreciation through Section 179 or other tax planning tools.
For instance, Section 179 allows business owners to deduct the cost of certain property improvements immediately, up to $1.22 million in 2024. When combined with cost segregation, this deduction can provide a significant tax benefit, especially for owner-occupied properties.
Understanding the complexities of cost segregation and navigating the 2024 tax landscape can be overwhelming. That’s where TaxPlanIQ comes in. Designed specifically for tax professionals, TaxPlanIQ allows you to easily create and customize tax plans for your clients. With its comprehensive database of tax strategies—including cost segregation—it offers a clear and easy-to-follow guide on how to implement these strategies to maximize your clients' savings.
By using TaxPlanIQ, you can streamline the cost segregation process, from identifying qualified assets to showing the tax savings potential for your clients. Best of all, you can create branded tax plans in just a few clicks, helping you expand your advisory services and grow your firm’s revenue.
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