If you clicked on this article, more power to you. Just reading the words “cost segregation” is enough to make about half the population fall asleep where they sit. That said, if you own any sort of commercial real estate, it’s a concept to at least be aware of.
Before we look at an overview of key concepts, I’ll say this: you don’t need to be an expert personally. If you are a client of Napier, we have a standard practice of connecting with your tax professionals and collaborating on this topic on your behalf.
Now, a basic definition. Many investors and business owners are familiar with depreciation as a tax strategy, and any owned real estate fits this category. The problem is that the IRS (by default) sets depreciation timelines of 27.5 years for residential and 39 years for commercial properties. I don’t know about you, but I would love it if my HVAC lasted that long.
The good news is that you don’t have to treat a building like one big, equally-depreciating asset. The IRS lets you break it down into parts—flooring, lighting, HVAC systems—and depreciate those parts faster. That means bigger deductions sooner, and more cash flow in the years you likely need it most.
Here’s what you should know.
What It Is (in Plain English)
Cost segregation is the process of reclassifying components of a commercial or investment property into shorter depreciation lives—typically 5, 7, or 15 years instead of 27.5 or 39.
This accelerates depreciation, which accelerates deductions, which means more tax savings up front.
Why It Matters
- It can lower your tax bill early. Front-loads depreciation when you may need it most—after a purchase, renovation, or expansion.
- Creates real cash flow. Many of our clients use the tax savings to reinvest, fund estate planning strategies, or pay down debt.
- Pairs well with business ownership. If you own the building your business operates in, the savings can impact both sides of your financial life.
When It Works Best
- You’ve recently acquired or improved a building
- You own real estate through a business or as part of an investment portfolio
- You’re looking to offset high income in the early years of ownership
- You qualify as a real estate professional or make a grouping election
Key Planning Moves
1. Grouping Election
If you own both the business and the building, you can elect to group them for tax purposes. This lets passive real estate losses offset active business income—something most investors miss without coordinated planning.
2. Timing Is Everything
Cost segregation works best when planned early. Wait too long, and you might miss the window for optimal benefit—or worse, throw off other parts of your tax and estate plan.
3. Know Your Role
If you’re not a real estate professional (per IRS rules), your losses may be passive—and limited. Structuring ownership properly or using short-term rentals may shift that dynamic.
Why It Needs to Be Coordinated
A cost segregation study does not live in isolation. The deductions it creates ripple through your tax return, cash flow, estate plan, and even future sale strategy. We have seen people get big depreciation on paper—only to realize later it triggered passive loss limits, created state tax surprises, or disrupted other planning moves.
This is the kind of strategy that works best when it is thought through early and connected to the rest of your plan. Cost seg can be powerful—but only when the timing, structure, and context are right.
