Cost segregation is a powerful tax analysis technique that helps property owners accelerate depreciation. By reclassifying short-lived components—like flooring, appliances, lighting, and landscaping—into shorter recovery periods, investors can front-load deductions, cut taxable income, and boost cash flow immediately instead of waiting decades.

This strategy is especially valuable for commercial buildings and multifamily rentals, where purchase prices and personal property components are large enough to justify the analysis. Smaller residential rentals benefit less often, but for the right property the payoff can be substantial.

Take Sarah, who owns six multifamily properties across three states, generating $2.3 million in annual gross rental income. When she came to Town, Head of Tax Anjum Tunuli found she had overpaid her tax bill by $47,000—simply because she depreciated her 12-unit apartment building on the default 27.5-year schedule instead of accelerating deductions on the parts that qualified for much shorter lives.

What Cost Segregation Actually Does for Your Rental Properties

When you buy a building, the IRS doesn’t require you to treat the entire purchase as a single long-lived asset. Without a study, you depreciate the whole structure over 27.5 years for residential rentals or 39 years for commercial property.

But a property isn’t just walls and a roof. A cost segregation study breaks it down into components—flooring, appliances, lighting, landscaping, HVAC systems—many of which wear out far sooner than 27.5 or 39 years.

By reclassifying those components into shorter recovery periods (5, 7, or 15 years), you unlock accelerated depreciation. The result is larger deductions in the early years and more cash flow available to reinvest in your business.

For Sarah’s 12-unit multifamily building, Town’s Head of Tax, Anjum Tunuli, showed that this difference translated into tens of thousands of dollars in extra deductions in just the first year.

Why the 2025 Tax Law Makes Cost Segregation Even More Powerful

The tax advantages of cost segregation aren’t new, but the One Big Beautiful Bill Act (OBBBA) supercharged them starting in 2025. These changes mean the deductions uncovered in a cost segregation study can be even larger and available sooner:

• Section 179 limits doubled. You can now expense up to $2.5 million of qualifying property immediately (phase-out begins at $4 million, up from $3.13 million).
  
  

• 100% bonus depreciation is permanent. Property placed in service after January 19, 2025, can be fully deducted in the year it’s purchased—no more phase-out schedule.
  
  

• Special 100% depreciation for production facilities. A new rule allows full expensing for certain nonresidential real estate used in manufacturing, agriculture, or refining. This doesn’t apply to most rental properties, but it’s worth noting for mixed-use or industrial investors.

The bottom line: cost segregation studies have already created faster deductions. With bonus depreciation restored and Section 179 expanded, the timing and size of those deductions are even more favorable in 2025 and beyond.

Qualifying Property Components: The Long and Short of It

Not every part of a property depreciates at the same pace. A cost segregation study sorts assets into buckets with different recovery periods. The key distinction: if something can be removed or replaced without harming the building’s structure, it often qualifies for faster depreciation.

5-Year Property

• Flooring and carpeting

• Appliances (refrigerators, washers, dryers)

• Specialty lighting and decorative fixtures

• Window treatments and blinds

• Security systems and cameras

7-Year Property

• Built-in furniture and fixtures

• Office equipment and computers

• Specialty plumbing and electrical that serve equipment (not structural)

• Signage and exterior decorative elements

15-Year Property (Improvements)

• Landscaping and irrigation systems

• Driveways, sidewalks, and parking areas

• Fencing and gates

• Outdoor amenities

• Site lighting and electrical distribution

• Outdoor recreational facilities (playgrounds, courts, etc.)

• Decks and hot tubs

27.5-Year Property (Residential Rentals)

• Building structure and foundation

• Roof, load-bearing walls, and framing

• Electrical and plumbing systems (structural portions)

• Fire safety systems and elevators

39-Year Property (Non-Residential/Commercial Rentals)

• Same categories as above, but with a longer recovery period

• Applies to office buildings, retail centers, warehouses, and other commercial rentals

A cost segregation study doesn’t change the total amount you depreciate—it changes the timing. By shifting more of the property into the shorter categories, you capture deductions sooner and keep more cash in hand to reinvest.

Planning Note: Recent law changes expanded Section 179 expensing to allow immediate write-offs for certain nonresidential property improvements (including roofs, HVAC, fire protection, and security systems). These rules generally don’t apply to residential rentals, but if you own mixed-use or commercial property, it’s worth reviewing whether an upgrade might qualify.

When Cost Segregation Makes Financial Sense

A cost segregation study isn’t free—it typically runs between $5,000 and $15,000 for smaller multifamily buildings, and can reach $25,000 or more for large commercial properties. That means the payoff has to justify the upfront cost.

Properties That Benefit the Most:

• Purchase price above $500,000

• Newly constructed buildings or major renovations

• Multifamily complexes, commercial, or mixed-use properties

• Rentals with significant personal property components (appliances, amenities, site improvements)

• High-income owners in top tax brackets who need deductions right now

When It May Not Pencil Out:

• Properties purchased for less than $300,000

• Owners with limited taxable income to offset

• Properties you plan to sell within 2–3 years (recapture may erase the benefit)

• Buildings with minimal short-lived components

For example, Sarah’s $800,000 multifamily building easily justified the $8,500 cost of a study. Anjum connected her with a trusted cost segregation partner, and the study uncovered over $12,000 in first-year tax savings—enough to cover the study’s cost and still come out ahead.

Real Numbers: How Cost Segregation Impacts Your Tax Bill

Let’s return to Sarah’s 12-unit apartment building, purchased for $800,000 (with $150,000 allocated to land).

Supercharged Under 2025 Law: With 100% bonus depreciation restored, Sarah could deduct the full $80,000 of 5- and 7-year property in year one—plus regular depreciation on the rest. That drives her total year-one deduction even higher, turning tax savings into immediate cash flow she can reinvest.

A professionally prepared study also provides audit-ready documentation, which is critical if the IRS ever reviews the allocations.

The Process: What Actually Happens During a Study

A high-quality cost segregation study follows a structured process grounded in IRS guidance. Here’s what to expect once you hire a qualified provider:

1. Site Inspection: An engineer or construction specialist visits the property, documents components with photos and measurements, and notes anything that qualifies for shorter depreciation. A mid-sized apartment building inspection usually takes 2–4 hours.
   
   

2. Document Review: Purchase agreements, construction contracts, invoices, and architectural plans are analyzed to tie actual costs to specific property components.
   
   

3. Engineering Analysis: Using cost databases like R.S. Means or Marshall Valuation Service, the team calculates replacement costs for each component and allocates them into 5-, 7-, 15-, or 27.5-year categories.
   
   

4. Legal Classification: Each item is reviewed against IRS rules, court cases, and prior IRS rulings to ensure the classification can stand up under scrutiny.
   
   

5. Report Preparation: You receive a detailed report documenting the methodology, cost breakdowns, and legal support. This becomes your audit-ready evidence if the IRS ever asks questions.

From start to finish, most studies take 4–6 weeks. For Sarah’s 12-unit building, the inspection and analysis wrapped up in just over a month, long before her tax filing deadline.

Working with the Right Professionals

Cost segregation is not a DIY project. The IRS has made it clear in its Cost Segregation Audit Techniques Guide that only detailed, engineering-based studies carry weight in an audit. A poorly prepared report can undo the very tax benefits you’re counting on.

What to Look For in a Qualified Provider:

• Engineering or construction background (mechanical, civil, or structural)

• Certified cost estimator credentials

• Experience defending studies in IRS audits

• Detailed methodology tied to construction cost databases and court precedents

• References from projects similar to yours

Red Flags That Signal Trouble:

• “Rule of thumb” percentage allocations with no supporting data

• Rock-bottom fees that don’t cover a proper site inspection

• Guarantees of specific tax savings without analysis

• Generic reports that don’t reflect your actual property

For Sarah, spending $8,500 on a professional study was a no-brainer. The report not only delivered $12,000 in first-year savings but also provided audit-ready documentation. That peace of mind is as valuable as the deductions themselves.

Managing Depreciation Recapture When You Sell

Cost segregation accelerates deductions today, but there’s a tradeoff: depreciation recapture. When you sell the property, the IRS taxes the depreciation you claimed—up to 25% for real property (unrecaptured §1250 gain) and at ordinary income rates for personal property.

That doesn’t mean cost segregation is a bad deal. The time value of money usually wins. Getting $10,000 in tax savings today is far more powerful than paying $2,500 in recapture a decade from now—especially if those savings are reinvested.

Ways to Manage Recapture:

• 1031 Exchange – Roll the gain into a new property and defer recapture indefinitely.

• Installment Sale – Spread recognition of recapture across multiple years.

• Charitable Remainder Trust (CRT) – Donate the property, eliminate recapture, and generate income over time.

• Sell in a Lower-Income Year – Time the sale when your marginal tax rate is lower.

For Sarah, recapture planning wasn’t a deterrent. The extra deductions gave her the cash flow to acquire another multifamily property, multiplying her long-term wealth even after factoring in eventual recapture. With guidance from Town, she understood both the benefits now and the tax implications later.

Integrating Cost Segregation with Other Tax Strategies

Cost segregation delivers the biggest payoff when it’s part of a coordinated tax plan rather than a stand-alone move. The deductions you unlock can be paired with other provisions in the tax code to amplify results:

• Real Estate Professional Status (REPS). If you or a spouse qualifies, passive losses from cost segregation can offset ordinary income without limitation—turbocharging the benefit.

• Section 199A Deduction. Rental income may qualify for the 20% qualified business income (QBI) deduction. Combining QBI with accelerated depreciation can lower your effective tax rate dramatically.

• Portfolio Planning. Owners of multiple properties can stagger cost segregation studies to maximize deductions in high-income years.

• Entity Structure. The choice of LLC, S corporation, or other structure influences how depreciation flows through and interacts with your overall tax picture.

Sarah used her extra deductions not just to save on taxes, but also to structure her rentals more efficiently. With guidance from Anjum Tunuli at Town, she timed cost segregation studies across her six multifamily properties to align deductions with her peak income years—reducing her overall tax burden and strengthening long-term cash flow.

Common Mistakes That Trigger IRS Scrutiny

The IRS knows cost segregation can be abused, which is why it published a Cost Segregation Audit Techniques Guide. Studies that cut corners tend to attract attention. Here are the errors that most often cause trouble:

• Weak Documentation. Reports that lack a site inspection, engineering analysis, or legal citations rarely survive an audit.
  
  

• Aggressive Allocations. Trying to classify structural elements (like walls or plumbing mains) as short-lived property is a red flag.
  
  

• Inconsistent Methods. Mixing different cost-estimation approaches without reconciliation undermines credibility.
  
  

• Missing Form 3115. If you’re changing depreciation methods, you must file Form 3115 (Application for Change in Accounting Method) with your return.
  
  

• Unqualified Preparers. “Rule of thumb” studies from firms without engineering or tax expertise are often tossed out by auditors.

Drawing on his experience with clients, Anjum Tunuli notes that IRS challenges usually arise from sloppy or overly aggressive studies—not from cost segregation itself. His guidance: “When a study is engineered properly and backed by solid documentation, cost segregation is fully defensible and delivers powerful tax benefits.”

The Bottom Line for Rental Property Owners

Cost segregation isn’t just an accounting exercise—it’s a way to unlock cash flow that would otherwise be tied up in slow depreciation schedules: 27.5 years for residential rentals and 39 years for commercial property. For the right building, the numbers can be game-changing, especially under the 2025 tax law that restored permanent 100% bonus depreciation and doubled Section 179 limits for commercial improvements like roofs, HVAC, and fire protection systems.

But it’s not a one-size-fits-all strategy. Smaller rentals or short-term holds may see little benefit once study costs and depreciation recapture are factored in. Larger multifamily properties and higher-value commercial buildings—owned by investors with meaningful taxable income—stand to gain the most.

The key is execution. With a properly engineered, IRS-defensible study, cost segregation can transform long-term write-offs into immediate tax savings—fueling reinvestment and wealth building. With a cut-rate or poorly documented study, it can trigger audits and back taxes.

Bottom line: treat cost segregation as part of a broader real estate tax plan. Done correctly, it’s one of the most effective tools available for accelerating deductions, improving cash flow, and compounding long-term returns.

Ready to see if cost segregation makes sense for your multifamily or commercial properties? Town’s tax advisors don’t just run the numbers—we look at your entire portfolio, ownership structure, and long-term goals to make sure a study truly pays off. We partner with trusted engineers and cost specialists so you get audit-ready results and a strategy that maximizes deductions while fitting into your bigger wealth plan.

Disclaimer: This content is for educational purposes only and should not be considered personalized tax advice. Tax laws are complex and subject to change, especially with recent legislation. Every investor’s situation is different, and strategies that work well for one property owner may not be suitable for another. Consult a qualified tax advisor before making decisions about cost segregation or other tax strategies.