What is Cost Segregation?
Cost segregation is a tax strategy that breaks a real estate purchase into shorter-lived components (5-year personal property, 15-year land improvements) to accelerate depreciation. Often produces 20-40% additional first-year tax deductions vs straight 27.5-year depreciation.
A cost-segregation study, performed by a licensed cost-seg engineer, reclassifies parts of a building into 5-year (carpet, appliances, decorative lighting) and 15-year (parking lots, landscaping, fencing) categories — both depreciable much faster than the 27.5-year structural shell.
For a $500,000 residential rental, a typical cost-seg study might identify $80,000 in 5-year and $40,000 in 15-year property, generating roughly $25,000 of additional first-year depreciation vs straight-line.
Worth the $4,000-12,000 study cost on properties over ~$500k. Below that, the math usually doesn't justify the engineering fee. Bonus depreciation rules (currently 60% for 2026, phasing down) compound the benefit further.
Concepts that connect.
Depreciation is the annual non-cash tax deduction allowed against rental property income — residential is depreciated over 27.5 years, commercial over 39. It reduces taxable income without reducing cash flow, the single largest tax advantage of rental real estate.
Net Operating Income (NOI) is a rental property's annual gross rental income minus all operating expenses, before debt service and income taxes. NOI is the denominator of cap rate and the numerator of DSCR — it's the most-used number in rental underwriting.
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