How cost segregation tax savings works

Cost segregation is a tax strategy that involves reclassifying certain assets of a property from a longer depreciation schedule to a shorter one. This strategy can increase the amount of depreciation deductions that can be claimed each year, resulting in significant tax savings for property owners.

Let’s use the example of a house located at 123 Edna Ave to illustrate how cost segregation tax savings can work. Before any repairs or improvements, the house had a purchase price of $100,000, with the land value being $25,000 and the structure being $75,000. The owner then made improvements to the house, costing $250,000, which increased the value of the property to $350,000.

Under the standard depreciation schedule, the owner would depreciate the entire cost of the house over a period of 27.5 years. This means that each year, they could claim a deduction for 1/27.5 of the total cost of the house.

However, with cost segregation, the owner could reclassify certain assets of the property to shorter depreciation schedules. For example, assets such as the HVAC system, plumbing, electrical wiring, and flooring could be reclassified to a shorter schedule of 5, 7, or 15 years. This would allow the owner to claim more significant depreciation deductions for these assets in the earlier years of ownership.

Assuming that the owner reclassifies $100,000 worth of assets to a shorter depreciation schedule, they would be able to claim $3,636 more in depreciation deductions each year ($100,000/27.5 years – $100,000/15 years). Over the first 5 years of ownership, the total tax savings from cost segregation would be $18,180 ($3,636 x 5 years).

Overall, cost segregation can be a valuable tax strategy for property owners who have made significant improvements to their properties. By reclassifying certain assets to shorter depreciation schedules, owners can claim more significant depreciation deductions in the earlier years of ownership, resulting in significant tax savings

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