Standard accounting depreciates a commercial building over 39 years (or 27.5 years for residential). That means you deduct a small slice of the building's value each year.
But a building isn't just walls and a roof. It's also carpet, lighting, landscaping, and parking lots. These items wear out much faster than the structure itself.
The Engineering Study
A Cost Segregation Study is an engineering report that identifies and reclassifies these assets into shorter depreciation lives (5, 7, or 15 years). By doing this, you can front-load your tax deductions.
Bonus Depreciation
The Tax Cuts and Jobs Act (TCJA) supercharged this with "Bonus Depreciation," allowing you to deduct 100% of the value of these short-life assets in Year 1. (Note: Bonus depreciation is phasing down—60% in 2024, 40% in 2025—but it remains a massive benefit).
The Impact
On a $5 million building, a Cost Seg study might identify $1 million of 5-year assets. Instead of deducting that $1 million over 39 years ($25k/year), you might deduct $400k-$600k in Year 1. This can create a massive tax loss that offsets other income.
Recapture
The catch? When you sell the building, you have to pay tax on the depreciation you took (Recapture Tax). However, due to the time value of money, having the cash today is almost always better than paying the tax later. Plus, you can always 1031 Exchange into the next deal to defer the recapture.
Conclusion
If you plan to hold a property for at least 3-5 years, a Cost Segregation study is almost always a no-brainer. It creates immediate cash flow through tax savings.