Is Cost Segregation Always Worth It?
Cost segregation stands as one of the most powerful tax strategies available to real estate investors today. The potential benefits are compelling: by reclassifying property components from 27.5 or 39-year recovery periods into 5, 7, or 15-year assets, investors can dramatically accelerate depreciation deductions. When combined with bonus depreciation provisions (currently at 40% for 2025, 60% for 2024, 80% for 2023 and 100% for 2022), a well-executed cost segregation study can generate immediate five or six-figure tax deferrals.
However, despite these significant advantages, cost segregation isn't universally beneficial for all property owners. The financial calculation varies based on specific property characteristics, investor tax circumstances, and long-term investment strategy. You need to pay close attention because what generates substantial returns for one investor may yield minimal benefits for another.
Rather than making assumptions based on general industry enthusiasm, we'll examine the objective financial factors that should inform your decision about whether a cost segregation study makes economic sense for your particular investment.
However, despite these significant advantages, cost segregation isn't universally beneficial for all property owners. The financial calculation varies based on specific property characteristics, investor tax circumstances, and long-term investment strategy. You need to pay close attention because what generates substantial returns for one investor may yield minimal benefits for another.
Rather than making assumptions based on general industry enthusiasm, we'll examine the objective financial factors that should inform your decision about whether a cost segregation study makes economic sense for your particular investment.
Scenario 1: Low Depreciable Basis
The depreciable basis is determined by subtracting the value of the land (which cannot be depreciated) from the total property cost or adjusted basis.
For example, let’s say you purchase a property for $350,000 and the land is valued at $250,000, your depreciable basis is $100,000. This $100,000 represents the maximum amount you can depreciate over time.
The Core Issue
The problem arises when this depreciable basis is relatively small. Even if a cost segregation study successfully identifies a significant percentage of components that qualify for accelerated depreciation, the absolute dollar value may be insufficient to generate meaningful tax savings.
Consider this example:
For example, let’s say you purchase a property for $350,000 and the land is valued at $250,000, your depreciable basis is $100,000. This $100,000 represents the maximum amount you can depreciate over time.
The Core Issue
The problem arises when this depreciable basis is relatively small. Even if a cost segregation study successfully identifies a significant percentage of components that qualify for accelerated depreciation, the absolute dollar value may be insufficient to generate meaningful tax savings.
Consider this example:
- Property purchase price:$350,000
- Land value:$250,000
- Building value (depreciable basis):$100,000
- Cost segregation study fee:$4,500
- Typical reclassification results:25-30% to shorter recovery periods
In this scenario, even if 30% of the building components ($30,000) are reclassified to 5-year property and you apply 60% bonus depreciation (2024 rate), your first-year additional deduction would be approximately $18,000 beyond regular depreciation. For an investor in the 37% tax bracket, this represents about $6,660 in tax savings.
After subtracting the $4,500 cost of the study, your net first-year benefit would be only $2,160. Clearly, this marginal tax savings is not worth the time/effort of performing a cost segregation study.
Decision Point
Before proceeding with a cost segregation study, calculate your property's depreciable basis and estimate the potential first-year tax savings based on your tax bracket. Most reputable cost segregation firms will do this for you if you request an “EOB” (Estimate of Benefits). If the projected net benefit (after the study cost) doesn't exceed $10,000 then it might not be worth it to perform the study.
After subtracting the $4,500 cost of the study, your net first-year benefit would be only $2,160. Clearly, this marginal tax savings is not worth the time/effort of performing a cost segregation study.
Decision Point
Before proceeding with a cost segregation study, calculate your property's depreciable basis and estimate the potential first-year tax savings based on your tax bracket. Most reputable cost segregation firms will do this for you if you request an “EOB” (Estimate of Benefits). If the projected net benefit (after the study cost) doesn't exceed $10,000 then it might not be worth it to perform the study.
Scenario 2: Highly Unfavorable Land-to-Building Ratio
High land valuation is your worst enemy when it comes to cost segregation. This is very common in high-value markets - such as California (where a small 1500sqft SFH can be worth $1.2M due to the land alone) or for waterfront properties.
Land Cannot Be Depreciated
The IRS is absolutely clear on this point: land cannot be depreciated under any circumstances. Cost segregation studies can only reclassify building components and land improvements—never the land itself. This becomes a problem when land represents an unusually high percentage of a property's total value.
The Core Issue: Diminished Available Basis
In markets with premium land values, you might face a severely restricted depreciable basis regardless of the property's total purchase price. This scenario is particularly common in:
Land Cannot Be Depreciated
The IRS is absolutely clear on this point: land cannot be depreciated under any circumstances. Cost segregation studies can only reclassify building components and land improvements—never the land itself. This becomes a problem when land represents an unusually high percentage of a property's total value.
The Core Issue: Diminished Available Basis
In markets with premium land values, you might face a severely restricted depreciable basis regardless of the property's total purchase price. This scenario is particularly common in:
- Coastal areas with waterfront properties
- Prime urban markets like San Francisco, New York, or Boston
- High-demand neighborhoods in cities like Los Angeles, Seattle, or Miami
- Resort destinations where land commands premium prices
For example, consider a $1.2 million single-family home in coastal California or a prime neighborhood in San Francisco. In these markets, it's not uncommon for the land to represent 70-80% of the property's total value. This means that even for this relatively expensive property:
- Total purchase price:$1,200,000
- Land value (75%):$900,000
- Building value (depreciable basis):$300,000
California Property Value & Depreciation Analysis
San Francisco Single-Family Home
$1,200,000
Property Breakdown
75%
Land Portion
25%
Building Portion
$900K
Land Value
$300K
Building Value
Year 1 Tax Deduction Comparison
First-Year Tax Savings
$37,100
Based on 33% effective tax rate
Cash Flow Improvement
15.6x
Compared to standard depreciation
In prime California markets like San Francisco, land values often represent 70-80% of the total property value. Be sure to discuss these specifics with your cost segregation company.
Despite a large initial investment ($1.2M), the actual depreciable basis remains modest (still something though!). That said, many companies will offer lower cost options for properties with smaller depreciable basis. For example Maven Cost Segregation offers their “Condensed Engineering Cost Segregation Study” where a virtual site visit eliminates the need for an in-person site visit and in return saving on study cost.
Context: Market-Specific Considerations
This unfavorable ratio is most pronounced in locations with sustained appreciation where land values have dramatically outpaced improvement values. A modest 1,500 square foot home sitting on a $900,000 lot presents fundamentally different cost segregation economics than the same structure on a $150,000 lot in another market.
This is not to discourage you if your property has a high land to value ratio, only to say its something to take into consideration.
Context: Market-Specific Considerations
This unfavorable ratio is most pronounced in locations with sustained appreciation where land values have dramatically outpaced improvement values. A modest 1,500 square foot home sitting on a $900,000 lot presents fundamentally different cost segregation economics than the same structure on a $150,000 lot in another market.
This is not to discourage you if your property has a high land to value ratio, only to say its something to take into consideration.
Scenario 3: Inability to Fully Utilize Losses
This is likely the biggest issue with cost segregation for many investors. The practical ability to utilize the generated tax losses. Make sure to discuss REPs status or the STR Loophole with your cost segregation company before ordering a study.
The Default Challenge: Passive Activity Loss (PAL) Limitations
For most investors, rental real estate activities are classified as passive activities by default under IRS rules. This classification has substantial implications for tax loss utilization. The general rule is straightforward but restrictive: passive losses can only offset passive income for non-real estate professional investors.
For example, if your cost segregation study generates $100,000 in additional first-year depreciation deductions but you have only $20,000 in passive income from other investments, you can only utilize $20,000 of those deductions in the current tax year. The remaining $80,000 becomes "suspended losses" that carry forward indefinitely until you either:
The Default Challenge: Passive Activity Loss (PAL) Limitations
For most investors, rental real estate activities are classified as passive activities by default under IRS rules. This classification has substantial implications for tax loss utilization. The general rule is straightforward but restrictive: passive losses can only offset passive income for non-real estate professional investors.
For example, if your cost segregation study generates $100,000 in additional first-year depreciation deductions but you have only $20,000 in passive income from other investments, you can only utilize $20,000 of those deductions in the current tax year. The remaining $80,000 becomes "suspended losses" that carry forward indefinitely until you either:
- Generate sufficient passive income in future years
- Dispose of the property in a fully taxable transaction
These suspended losses provide no immediate tax benefit against your W-2 income, business income, or portfolio income (dividends, interest, capital gains), regardless of how large they appear on paper. Without careful tax planning, this can effectively negate the time-value-of-money benefit that makes cost segregation worthwhile.
Important Exception 1: Spousal REPS Status
The Real Estate Professional Status (REPS) provides a significant exception to PAL rules. If you or your spouse qualifies as a real estate professional and you materially participate in your rental activities, your rental losses may be reclassified as non-passive losses capable of offsetting any type of income.
To qualify for REPS, you must meet stringent criteria:
To qualify for REPS, you must meet stringent criteria:
- Perform more than 750 hours of services during the tax year in real estate trades or businesses
- Spend more than 50% of your total working time in real estate trades or businesses
- Materially participate in each rental activity (or elect to group activities)
For married couples filing jointly, only one spouse needs to satisfy these requirements. This is perfect for scenarios where one spouse maintains a full-: one spouse can maintain full-time employment while the other qualifies as a real estate professional, allowing the couple to fully utilize accelerated depreciation deductions against their combined income.
Important Exception 2: The Short-Term Rental (STR) "Loophole"
Short-term rental properties present a unique opportunity within the tax code. Under certain conditions, STRs may avoid classification as "rental activities" altogether, potentially bypassing PAL limitations even without REPS status.
For an activity to qualify for this exception, it must meet specific criteria:
For an activity to qualify for this exception, it must meet specific criteria:
- The average period of customer use must be 7 days or less, OR
- The average period of customer use is 30 days or less AND significant personal services are provided
When an STR meets these criteria, the activity is treated as a business rather than a rental activity. If you materially participate in this business (meeting one of the seven IRS material participation tests), losses generated may be considered non-passive, allowing them to offset other income types regardless of REPS status.
This creates an important distinction: cost segregation can be highly valuable for qualifying, materially participating STR owners in situations where it would provide limited current benefit for traditional long-term rental property owners with similar tax profiles.
Understanding these nuanced exceptions is critical when evaluating whether a cost segregation study will generate immediate tax benefits or merely create suspended losses with deferred value.
This creates an important distinction: cost segregation can be highly valuable for qualifying, materially participating STR owners in situations where it would provide limited current benefit for traditional long-term rental property owners with similar tax profiles.
Understanding these nuanced exceptions is critical when evaluating whether a cost segregation study will generate immediate tax benefits or merely create suspended losses with deferred value.
Scenario 4: Extremely Short Intended Holding Period
Time-value-of-money is what makes cost segregation “work”. By accelerating depreciation deductions, you effectively receive an interest-free loan from the government—but this advantage diminishes substantially with very short holding periods - for several reasons.
Does cost segregation work on a short time scale?
Cost segregation generates its financial benefit through tax deferral, not permanent tax elimination. The magnitude of this benefit correlates directly with how long you hold the property after implementing the study. With extremely short holding periods (1-3 years), there are several issues:
Does cost segregation work on a short time scale?
Cost segregation generates its financial benefit through tax deferral, not permanent tax elimination. The magnitude of this benefit correlates directly with how long you hold the property after implementing the study. With extremely short holding periods (1-3 years), there are several issues:
- The time-value benefits are compressed into a short window
- The study itself represents a higher percentage of savings
- The delayed impact of depreciation recapture occurs much sooner than planned
For example, if your cost segregation study generates $75,000 in first-year tax savings but you sell the property just two years later, you've had limited time to reinvest and compound those savings. Also, you will face depreciation recapture taxes earlier, reducing the net economic benefit.
Holding Period Impact on Cost Segregation Benefits
Year 0
Property Purchase
Year 2
Short-Term Hold
$10K Net Benefit
Year 5
Medium-Term Hold
$42K Net Benefit
Year 10
Long-Term Hold
$76K Net Benefit
Standard Depreciation
Accelerated Depreciation with Cost Segregation
Short Hold
Selling within 2-3 years significantly reduces benefit and triggers early recapture.
Tax Deferral:
Low
Recapture:
High
ROI:
Often Negative
Medium Hold
A 5-7 year hold allows for meaningful compounding while delaying recapture.
Tax Deferral:
Moderate
Recapture:
Moderate
ROI:
Positive
Long Hold
Holding 10+ years maximizes benefit and may enable recapture avoidance via 1031 exchanges.
Tax Deferral:
High
Recapture:
Minimal
ROI:
Substantial
Expert Recommendation: For maximum benefit, plan for at least a 5-year holding period. Properties intended for 10+ year holds typically generate the highest return on cost segregation studies, especially when combined with 1031 exchange strategies.
* Analysis assumes a $2M property with 37% tax bracket investor. Net benefit calculation incorporates time value of money at 5% reinvestment rate and accounts for depreciation recapture costs.
Recapture Consideration: The Forgotten Cost
When evaluating cost segregation for short-term holds, investors often overlook depreciation recapture (it is also worth noting that a 1031 exchange or Delaware Statutory Trusts (DSTs) can help you fully avoid recapture).
Upon sale, depreciation taken on 5-, 7-, and 15-year property is generally recaptured under Section 1245 at ordinary income tax rates (up to 37%)—not the 25% unrecaptured Section 1250 rate that applies to buildings. This makes early recapture even more expensive and reduces the net benefit of cost segregation on short holds.
This results in an important question: Is the short-term deferral benefit sufficient to offset both the study cost and the eventual recapture tax differential?
For example:
Upon sale, depreciation taken on 5-, 7-, and 15-year property is generally recaptured under Section 1245 at ordinary income tax rates (up to 37%)—not the 25% unrecaptured Section 1250 rate that applies to buildings. This makes early recapture even more expensive and reduces the net benefit of cost segregation on short holds.
This results in an important question: Is the short-term deferral benefit sufficient to offset both the study cost and the eventual recapture tax differential?
For example:
- Property purchase:$2,000,000
- Cost segregation study fee:$8,000
- Additional first-year depreciation from study:$200,000
- Tax savings at 37% bracket:$74,000
- Holding period:2 years
- Interest rate for reinvested savings:5%
After compounding the $74,000 tax savings for two years, you'd have approximately $81,585. However, upon sale, that $200,000 in accelerated depreciation is recaptured at your ordinary rate (up to 37%)—potentially triggering $74,000 in recapture tax.
This effectively cancels out the earlier tax benefit, especially when factoring in the $8,000 study fee. For short-term holds, this narrow margin—or even net loss—makes cost segregation a riskier play, particularly for those in lower brackets or with limited time to redeploy tax savings.
This effectively cancels out the earlier tax benefit, especially when factoring in the $8,000 study fee. For short-term holds, this narrow margin—or even net loss—makes cost segregation a riskier play, particularly for those in lower brackets or with limited time to redeploy tax savings.
Bonus Depreciation Context: Declining Benefits
The current phase-down of bonus depreciation further impacts short-term hold economics. Under the Tax Cuts and Jobs Act provisions:
- 2023:80% bonus depreciation
- 2024:60% bonus depreciation
- 2025:40% bonus depreciation
- 2026:20% bonus depreciation
- 2027 and beyond:0% (reversion to standard depreciation methods)
Author’s Note: This article was written April 4th 2025 and as of this date the Trump Tax Plan is currently going through finalization, there is a good probability that 100% bonus depreciation will return in 2025 or 2026 so please be aware.
With this scheduled reduction, the immediate benefit of cost segregation is already diminishing year by year. For investments with intended holding periods of 1-3 years that will sell during later phase-down years, the initial benefit is reduced while the recapture cost remains unchanged.
Before ordering a cost segregation study for a property you plan to sell quickly, calculate the specific after-tax benefit with your holding timeline, incorporating both the time value of the tax deferral and the eventual recapture costs at disposition. For many short-term investments, traditional straight-line depreciation may provide a more favorable risk-adjusted return when all factors are considered.
With this scheduled reduction, the immediate benefit of cost segregation is already diminishing year by year. For investments with intended holding periods of 1-3 years that will sell during later phase-down years, the initial benefit is reduced while the recapture cost remains unchanged.
Before ordering a cost segregation study for a property you plan to sell quickly, calculate the specific after-tax benefit with your holding timeline, incorporating both the time value of the tax deferral and the eventual recapture costs at disposition. For many short-term investments, traditional straight-line depreciation may provide a more favorable risk-adjusted return when all factors are considered.
Scenario 5: Minimal Overall Tax Liability
While cost segregation can generate significant tax deductions, these deductions only provide economic value when you have sufficient tax liability to offset. For investors with minimal overall tax liability, the benefits of accelerated depreciation may be largely theoretical rather than practical.
When Tax Deductions Have Limited Value
There are multiple cases where an investor has little to no federal income tax liability to offset:
- Investors that already have large passive loss carryforwards
- Recent retirees or those with low income streams
- Investors with other tax credits (like Low-Income Housing Tax Credits)
- Individuals with extensive business losses or carryforwards
In these cases, additional depreciation deductions from cost segregation may generate little to no immediate tax benefit, essentially "wasting" potential deductions that could be more valuable in future higher-income years.
Core Issue: Deductions Without Tax Liability
The fundamental principle is straightforward: a tax deduction's value is directly proportional to your marginal tax rate. If your taxable income is already minimal or zero before considering additional depreciation deductions, those deductions provide negligible immediate benefit.
Consider this example:
Consider this example:
- Investor's gross income:$150,000
- Standard or itemized deductions, existing rental losses, and other write-offs:$145,000
- Taxable income before cost segregation:$5,000
- Federal tax liability at 10% bracket:$500
- Additional depreciation from cost segregation:$50,000
- Cost segregation study fee:$4,500
In this case, an additional $50,000 in depreciation only saves $500 in taxes (eliminating the remaining tax liability), while costing $4,500 for the study - obviously this isn’t worth it. That said, the excess $45,000 in deductions does carry forward as suspended passive losses.
For investors in this position, cost segregation essentially converts current deductions into future deductions without providing immediate cash flow benefits. The risk is that your tax situation might never allow full utilization of these accumulated losses, particularly if you remain in lower tax brackets or continue generating additional passive losses each year.
Before pursuing cost segregation, analyze your projected tax liability for the current year and several years forward. If you anticipate minimal tax liability due to other deductions, credits, or income circumstances, consider postponing cost segregation until a year when the accelerated deductions would provide more substantial immediate benefits.
For investors in this position, cost segregation essentially converts current deductions into future deductions without providing immediate cash flow benefits. The risk is that your tax situation might never allow full utilization of these accumulated losses, particularly if you remain in lower tax brackets or continue generating additional passive losses each year.
Before pursuing cost segregation, analyze your projected tax liability for the current year and several years forward. If you anticipate minimal tax liability due to other deductions, credits, or income circumstances, consider postponing cost segregation until a year when the accelerated deductions would provide more substantial immediate benefits.
Final Thoughts: When to Get a Cost Segregation Study
When properly applied, cost segregation remains one of the most powerful tax strategies available to real estate investors. However, as we've explored throughout this article, its benefits aren't universal. Let's recap the key scenarios where cost segregation might not be ideal:
- 1. Very Low Depreciable Basis:Properties with limited building value relative to land value may not generate sufficient accelerated depreciation to justify study costs.
- 2. Highly Unfavorable Land-to-Building Ratio:High-value land areas (coastal properties, premium urban markets) where land constitutes 70-80% of property value significantly restrict potential benefits.
- 3. Passive Activity Loss Limitations:Without Real Estate Professional Status or qualifying short-term rental activities, accelerated depreciation may create suspended losses rather than immediate tax benefits.
- 4. Very Short Holding Periods:The compressed timeline for 1-3 year holds minimizes the time-value benefit while still triggering recapture taxes.
- 5. Low Overall Tax Liability:Investors with limited tax obligations cannot fully utilize additional deductions, regardless of their technical validity.
It’s important to note that these scenarios aren't absolute disqualifiers but rather critical analytical factors. Each property and investor's situation requires individualized analysis. The decreasing bonus depreciation rates (60% for 2024, 40% for 2025) further modify the calculation compared to previous years (although it is this author's - possibly wishful - opinion that Trump will likely bring back 100% bonus depreciation).
Before investing in a cost segregation study, make sure to talk to either a reputable cost segregation company or a tax professional who fully understands the subtleties of cost segregation. These experts can help give you an outline of your specific circumstances, helping avoid situations where the costs and complexities outweigh the benefits.
Before investing in a cost segregation study, make sure to talk to either a reputable cost segregation company or a tax professional who fully understands the subtleties of cost segregation. These experts can help give you an outline of your specific circumstances, helping avoid situations where the costs and complexities outweigh the benefits.
About the Author
Sean Graham, CPA specializes in cost segregation, tax depreciation, and real estate tax savings. As the Chief Technical CPA at Maven Cost Segregation: Tax Advisors, he has overseen 1000+ cost segregation studies, helping investors maximize deductions.