Real Estate Cost Segregation: How It Works and Why You Should Leverage It

Investing in real estate is one of the smartest moves you can make to grow your net worth and secure your financial future. But beyond the obvious benefits of rental income and property appreciation, there are significant tax advantages to owning real estate. One powerful strategy is cost segregation—a method that has saved me thousands of dollars in taxes while my properties continued to generate income and increase in value. Here, I’ll share what cost segregation is, how it works, and why it’s a game-changer for anyone with real estate holdings. I’ll also explain how bonus depreciation has amplified these benefits for my properties—and what changes are on the horizon as bonus depreciation is phased out. Plus, I’ll dive into my own experiences with my medical office building and short-term rentals (STRs), including Simpli SoHa in South Haven, Michigan, and my guest house STR.

What Is Cost Segregation?

Cost segregation is a tax strategy that allows property owners to accelerate depreciation deductions, reducing taxable income in the early years of owning a property. Instead of depreciating your building over the standard 27.5 or 39 years (depending on the property type), cost segregation breaks down your property into components that can be depreciated over shorter periods, such as 5, 7, or 15 years. These components might include things like flooring, lighting, cabinetry, or landscaping.

By reclassifying these assets, you can take larger depreciation deductions sooner, resulting in significant tax savings. This is especially useful for high-income professionals, like physicians, who often face hefty tax bills.

Bonus Depreciation: A Powerful Add-On

Bonus depreciation is a federal tax incentive that allows you to immediately deduct a large percentage of certain property costs in the year they’re placed into service. Until recently, bonus depreciation allowed 100% of qualifying costs to be deducted upfront, amplifying the benefits of cost segregation. I leveraged bonus depreciation for my properties, further reducing my taxable income and increasing cash flow.

However, bonus depreciation is being phased out. Starting in 2023, the deduction has begun decreasing by 20% annually, dropping to 80% in 2023, 60% in 2024, and so on, until it is fully phased out by 2027. This makes now an opportune time to act if you’re considering a cost segregation study to maximize your tax savings while bonus depreciation is still available.

How Cost Segregation Saves You Tax Money

Cost segregation works by accelerating the depreciation schedule of certain assets within your property. Here’s how the process typically unfolds:

1. Hire a Specialist: A cost segregation study is conducted by engineers and tax experts who analyze your property and identify components that qualify for accelerated depreciation.

2. Reclassify Assets: The study breaks down your property’s components into categories with shorter depreciation schedules.

3. Tax Deductions: You claim the increased depreciation deductions on your tax return, reducing your taxable income.

4. Cash Flow Boost: Lower taxes mean you keep more of your income, freeing up cash for reinvestment or other needs.

My Experience with Cost Segregation and Bonus Depreciation

1. The Medical Office Building

When I first learned about cost segregation, I owned a million-dollar medical office building leased to a hospital. This property was already generating consistent rental income, but the tax savings potential through cost segregation and bonus depreciation was too good to ignore. After conducting a cost segregation study, I was able to reclassify assets and immediately deduct a significant portion of the costs through bonus depreciation. The result? Tens of thousands of dollars in tax savings over the first few years.

The additional cash flow allowed me to reinvest in other ventures and improve the building’s facilities, further increasing its value and appeal to tenants. Meanwhile, the property continued to appreciate in value, creating a dual benefit of ongoing income and long-term growth.

2. Simpli SoHa in South Haven

My $1.3 million short-term rental property, Simpli SoHa, is not just a beautiful place along the shores of North Beach in South Haven, Michigan; it’s also a tax-saving powerhouse. With a cost segregation study and the application of bonus depreciation, I reclassified many components—like fixtures, appliances, and outdoor improvements—into shorter depreciation schedules. This move significantly reduced my taxable income, and the cash flow savings were reinvested into marketing and upgrades for the property.

Simpli SoHa has generated substantial rental income while also appreciating in value since I purchased it. The combination of income, tax savings, and appreciation has made this investment a cornerstone of my portfolio.

3. The Guest House STR

Even smaller properties, like my guest house STR that we call our Legacy House, benefit from cost segregation and bonus depreciation. The tax savings from accelerated depreciation on this property have been reinvested into other opportunities, including additional real estate purchases. These smaller wins add up, creating a snowball effect of wealth building.

Why Doctors Should Consider Real Estate

As physicians, we’re often focused on our clinical work and may overlook the incredible financial opportunities in real estate. Here’s why I recommend adding real estate to your portfolio:

1. Diversification: Real estate provides income streams separate from your clinical work, reducing financial dependence on your primary job.

2. Tax Advantages: Strategies like cost segregation and bonus depreciation significantly lower your taxable income, leaving more money in your pocket.

3. Appreciation: Properties generally increase in value over time, adding to your net worth.

4. Income Generation: Rental properties provide steady income, which can support your lifestyle or fund other investments.

5. Leverage: Real estate allows you to use financing to acquire high-value assets, magnifying your returns.

How to Get Started

If you’re ready to explore real estate or enhance your current investments, here’s how SimpliMD can help independent physicians benefit from real estate:

• Corporate Structures Like LLCs: Placing real estate in an LLC provides liability protection and makes it easier to manage your investments. LLCs can also streamline tax reporting and enhance asset protection.

• For Professional Micro-Corporations: If you operate as a professional micro-corporation, you can leverage many of our tailored business products to maximize the benefits of real estate ownership while growing your overall wealth. These include:

  • Professional Micro-Corporation Business Plan Bundle ($99): Access a tailored business plan template, SWOT template, and micro-business budget template designed to jumpstart your professional micro-corporation.

  • Build Your Business Team Guide Services ($500): To thrive as a self-employed doctor, you need a trusted team—lawyer, tax professional, wealth manager, and business coach—aligned with your goals. SimpliMD connects you to the experts who help you succeed.

Final Thoughts

Cost segregation and bonus depreciation have been game-changers for my financial journey, saving me tens of thousands in taxes while my properties continued to generate income and appreciate in value. If you own real estate or are considering investing, don’t miss out on these powerful strategies. With bonus depreciation being phased out, now is the time to act. It’s one more way to leverage your assets to achieve financial freedom and long-term wealth.

To learn more about how to use this important tool in your asset portfolio, I encourage you to SRMD’s Zero To Freedom Course that is enrolling for their spring session now. It will be worth every $$.