Summary: New tax legislation passed under the One Big Beautiful Bill makes cost segregation a more lucrative strategy for today’s real estate firms and investors. In this article, Aprio explains how cost segregation studies work and whether performing one is a smart decision for your property portfolio.
Cost segregation has been a valuable tax tool for many years, but with the One Big Beautiful Bill (OBBB), there’s renewed excitement.
Perhaps your CPA has mentioned cost segregation studies before, but you may not have fully understood their potential impact on your taxes. What is a cost segregation study? Why does it matter for real estate investors? When should you have one completed? In what situations would a study not make sense?
In this article, we’ll walk through these key questions to help you understand if a cost segregation study could be a smart next step for your real estate portfolio.
What is a cost segregation study?
A cost segregation study is a detailed analysis of a property that is typically depreciated over a standard period — 27.5 years for residential real estate or 39 years for commercial real estate. The purpose of the study is to identify and allocate building components of the property into shorter-lived asset categories, such as carpet and vinyl flooring, cabinetry, decorative lighting, and land improvements, which can be depreciated over a shorter timeframe.
Why do cost segregation studies matter for real estate investors?
By reallocating portions of the property’s cost basis into shorter recovery periods, the study enables property owners to accelerate depreciation deductions and significantly reduce taxable income in the early years of ownership. Because the OBBB reinstated 100% bonus depreciation, any portion of a building’s costs that can be allocated to shorter-lived asset categories becomes fully deductible in the year of the study rather than over decades.
Here is an example: A taxpayer purchases an apartment complex in July 2025 with improvement basis of $5 million. A cost segregation study determines that $1.5 million of that amount relates to assets with shorter recovery periods, such as land improvements and certain interior components. With changes made under the OBBB, providing 100% expensing of eligible bonus depreciation on property acquired after January 19, 2025, the $1.5 million will be fully expensed in the first year, assuming all other eligibility requirements for bonus depreciation are met. If the taxpayer is the sole owner of the property, has a combined federal and state tax rate of 45%, and has no limitations in the benefit of the deduction on their individual tax return, that equates to tax savings of $675,000.
As the example demonstrates, there is tremendous benefit in the ability to pull decades of depreciation into the current year and significantly improve cash flow. Additionally, because depreciation reduces taxable income without reducing actual cash, the tax savings from a cost segregation study frees up capital for renovations, new property acquisitions, debt service, and strengthening operating reserves.
A properly executed, engineering‑based cost segregation study not only delivers tax benefits but also strengthens audit defensibility due to the detailed component classification and supporting documentation. The IRS can challenge the costs allocated among the classes of property, but a study conducted by a qualified engineer provides greater certainty that the IRS will accept the allocations.
When to take advantage of a cost segregation study
To help maximize the tax benefits, it’s best to complete and implement a cost segregation study in the same tax year that the property is purchased. Ideally, investors should begin coordinating cost segregation as soon as the property purchase closes to help ensure the study will be completed before filing their tax return.
However, if timing doesn’t work out in the initial year, the investor can file Form 3115, which allows the accelerated depreciation benefit to be recognized in a tax year after the property has already been placed in service.
Significant property improvements provide another opportunity to utilize a cost segregation study. For example, if a taxpayer purchases an office building and five years later decides to convert the office space to apartment units, a study can identify the property with shorter depreciable lives. If the conversion cost is significant enough, and there is substantial property with depreciable life, the tax savings could justify the cost benefit of a study.
A cost segregation study can also provide a meaningful estate‑planning advantage. By performing a study after death and filing Form 3115 to take a catch‑up adjustment, the estate can immediately claim all previously unrecognized accelerated depreciation that would have been available had the property been classified correctly from the beginning.
This often-substantial “catch‑up” deduction reduces the decedent’s final income tax liability, preserving more assets for heirs without affecting the property’s stepped‑up basis at death. Because the step‑up resets the property’s depreciable basis for beneficiaries, the large one‑time deduction effectively becomes a free tax benefit: The estate captures decades of missed depreciation in a single year, lowers final taxes, and still allows heirs to start fresh with new depreciation based on the stepped‑up value. This makes cost segregation a uniquely powerful planning tool when applied at the end of an investor’s life.
When a cost segregation study may not be worthwhile
Professional cost segregation studies typically cost between $4,000–$20,000 depending on property type and size. If the potential accelerated depreciation doesn’t significantly exceed this cost, the ROI may not justify the effort.
Accelerating depreciation provides up‑front savings, but depreciation recapture on the sale must be considered. If an investor plans to sell the property very soon, the long‑term net benefit may be reduced. A 1031 exchange can preserve the benefit, but absent proper planning, early disposition can diminish value.
The value of a study on property that is later sold using a 1031 like-kind exchange can be further diminished, as the personal property identified in the study may not be eligible for 1031 treatment. Thus, if you have a cost segregation report that identified personal property, there could be gain if any of the value from the sales price is allocable to the personal property sold.
Note, however, that personal property identified for depreciation purposes isn’t necessarily personal property for purposes of a 1031 exchange. And even if some of the 1031 like-kind exchange tax benefit is reduced, the impact can often be mitigated by having a cost segregation study completed on the replacement property, though opportunities for claiming bonus depreciation are more limited.
Finally, cost segregation accelerates depreciation, which creates paper losses. But if an investor is subject to passive activity loss limitations, is not a real estate professional, or has limited taxable income to absorb losses, then the accelerated depreciation may not reduce current taxes and could defer the benefit until future years. Details of this qualification for real estate professionals and passive loss limitations are beyond the scope of this article, but Aprio’s Real Estate team is happy to discuss opportunities as they arise.
Final thoughts
With careful planning and consideration of all factors impacting the property and its investors, cost segregation studies are one of the most effective tax-saving strategies available to real estate investors. If you have questions about cost segregation studies and how they might impact your personal tax situation, consult your Aprio CPA for personalized guidance.
