Real Estate Cost Segregation Studies and How They Really Work

If you own investment properties—whether commercial, residential, or short-term rentals—you’ve probably heard the term “cost segregation study.” It sounds complex, but the reality is that understanding and applying cost segregation can save you thousands of dollars in taxes every year. I know this firsthand because I’ve done cost segregation studies on three properties I own within separate LLCs: my medical office building, my short-term rental (STR) Simpli SoHa in South Haven, and our "Legacy House" residential investment property.

Each of these properties is a micro-corporation within my business portfolio, and by leveraging cost segregation studies, I’ve significantly reduced taxable income, freeing up capital for reinvestment and growth. Let’s break down how cost segregation really works and how you can apply it to maximize tax savings within your own real estate investments.

What Is a Cost Segregation Study?

A cost segregation study is a strategic tax planning tool that allows property owners to accelerate depreciation deductions by reclassifying certain building components into shorter depreciation categories. Typically, a commercial or residential rental property is depreciated over 39 or 27.5 years, respectively. However, certain elements within a property—such as electrical wiring, plumbing, lighting fixtures, flooring, and even landscaping—can be reclassified into shorter depreciation periods of 5, 7, or 15 years.

This reclassification allows you to front-load depreciation expenses, reducing taxable income in the early years of property ownership and deferring tax payments—essentially keeping more money in your pocket today.

How Cost Segregation Studies Work in Practice

1. Property Analysis

The process starts with a detailed engineering study of your property. A cost segregation specialist will analyze construction costs, blueprints, and property records to determine which components can be classified for accelerated depreciation.

2. Reclassification of Assets

Instead of treating your entire property as a single depreciable asset over 27.5 or 39 years, a cost segregation study breaks it down into different components:

• 5-year assets: Carpeting, cabinets, electrical fixtures, certain appliances

• 7-year assets: Office furniture, some landscaping elements

• 15-year assets: Pavement, drainage systems, sidewalks

• 27.5 or 39-year assets: Structural components like walls, roofs, and foundations

3. Tax Savings and Increased Cash Flow

By shifting more of your depreciation to the earlier years of property ownership, you create significant tax deductions upfront, reducing taxable income. This increases your cash flow, allowing you to reinvest in additional properties, improvements, or other business ventures.

My Experience with Cost Segregation Studies

I’ve successfully conducted cost segregation studies on three properties, each owned within its own LLC:

1. Medical Office Building

As a physician and entrepreneur, I own a medical office building, and the cost segregation study on this property provided significant upfront tax savings. The study identified portions of the building—such as specialized electrical systems, cabinetry, and flooring—that could be depreciated over shorter periods, reducing my tax burden.

2. Simpli SoHa (Short-Term Rental in South Haven, MI)

My STR, Simpli SoHa, is a prime example of how cost segregation benefits real estate investors. Short-term rentals qualify for accelerated depreciation without the passive activity loss limitations of traditional rentals. Through the study, we reclassified elements like appliances, furniture, and certain exterior improvements, generating substantial deductions in the first few years of ownership.

3. Legacy House (Residential Investment Property)

Our “Legacy House” serves as a long-term residential rental, and the cost segregation study helped us capture depreciation much earlier than the standard 27.5-year schedule. This translated into thousands of dollars in tax savings while preserving cash flow for future investments.

Is Cost Segregation Right for You?

Cost segregation studies are ideal for real estate investors, physicians who own medical office buildings, and self-employed professionals with rental properties. However, they work best when:

• The property has a cost basis of $500,000 or more

• You plan to hold the property for several years

• You or your business generates enough income to take advantage of the deductions

If you’re a high-income earner (like most physicians), cost segregation can be a game-changer in reducing your tax liability.

The Power of 100% Bonus Depreciation

One of the biggest advantages of cost segregation in the past has been 100% bonus depreciation, which allows you to immediately deduct the full cost of qualifying property improvements in the first year. While bonus depreciation percentages are currently phasing down, you can still take advantage of these benefits for assets placed in service before the deadlines. There is some speculation that President Trump will re-institute !00% bonus depreciation this year.

Getting Started with Cost Segregation

1. Consult a Specialist: Work with a cost segregation firm or tax professional experienced in real estate tax strategy.

2. Determine Eligibility: If your property is valued at over $500,000, a study could provide significant tax savings.

3. Plan for Future Investments: The tax savings from a cost segregation study can fund future property purchases or reinvestment into your business.

Maximize Your Business Potential with SimpliMD

Cost segregation is just one of the many ways physicians and self-employed professionals can optimize their financial health. At SimpliMD, we provide business coaching and essential resources to help you build and grow your micro-corporation.

SimpliMD Offerings:

• $2,000 SimpliMD Business Coaching: Receive 1:1 holistic coaching tailored to small business growth, with flexible monthly or quarterly programs to fit your needs.

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

• $500 SimpliMD Build Your Business Team Guide Services: 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.

If you’re ready to take control of your financial future through real estate tax strategies and micro-corporation ownership, SimpliMD can help. Reach out today to start building your roadmap to success!