Cost segregation is a smart tax strategy that helps individuals and business owners, especially real estate investors, accelerate depreciation and increase cash flow. If you’ve purchased, built, renovated, or expanded a property, you can reclassify parts of it into shorter lifespans, resulting in bigger deductions now and lower taxable income.

With bonus depreciation back to 100% due to the new law, there has never been a better time to act. Even if you’ve held a property for years, IRS-approved retroactive strategies can help you claim missed deductions.

This blog breaks down how cost segregation works, who qualifies, and why it’s one of the smartest moves investors can make in 2025.

How does a Cost Segregation Study Work?

A cost segregation study is conducted by qualified professionals and follows these steps:

1. Property Assessment

• Review of blueprints, construction records, renovations, and site visits.

• Identification of components like HVAC, lighting, fixtures, sidewalks, and landscaping.

2. Cost Allocation

• Assign a cost value to each component using invoices, contracts, and industry standards.

3. Asset Classification

• Categorize items into 5, 7, 15, 27.5-year (residential rental property) or 39-year commercial property using IRS guidelines.

4. Depreciation Schedule Assignment

• Apply the appropriate accelerated or bonus depreciation method.

5. Comprehensive Report Delivery

• A detailed report is generated showing reclassified assets, costs, schedules, and all supporting documentation.

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How Far Back Can You Go?

If you’ve missed claiming depreciation on a property in past years, you don’t have to redo old tax returns. The IRS lets you file Form 3115 to fix it all at once in your current return, using a method called a Change in Accounting Method.

Watch Master the Basics of IRS Form 3115 for Tax Compliance to learn how it works and what steps to take.

Retroactive Filing Highlights:

• No amended returns required — all deductions are claimed in the current tax year.

• Applies to both new and older properties — even if acquired years ago.

• Not limited to REPS or STR owners — any eligible investment property can qualify if it generates taxable rental income or offsets passive gains.

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What Cost Segregation Actually Breaks Down Into

Instead of depreciating everything over a long period, the property is divided into:

This creates larger deductions sooner, which can supercharge your cash flow.

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Who Should Consider Cost Segregation?

Ideal Candidates:

• STR owners who materially participate

• LTR owners who qualify for REPS

• Households with passive income from rentals or K-1s

• Developers and investors who are improving properties

• Owners of commercial or residential rental properties worth $500,000+

Pros and Cons of Cost Segregation

Pros:

• Allows you to deduct more of an asset's cost early, leading to quicker tax savings.

• Accelerated depreciation reduces taxable income and boosts immediate cash flow.

• Retroactive studies can help claim missed depreciation and unlock major tax savings.

• Strong strategy for investors with long-term holdings or high upfront investments.

Cons:

• Must be performed by professionals, DIY is risky.

• Upfront cost typically ranges from $5,000 to $15,000, depending on complexity.

• Adds complexity to tax filings, requiring precise documentation and expert help.

• Depreciation recapture taxes can reduce gains if not planned for at the sale.

• Poorly done studies can raise IRS red flags, even though the process itself is approved.

Why Cost Segregation Matters in 2025

Bonus depreciation is officially back to 100%, confirmed by new law in early July. This applies to property acquired and placed in service between January 20, 2025, and December 31, 2029, giving real estate investors and property owners an unmatched opportunity to maximize first-year deductions and front-load tax savings. Whether you’re acquiring, improving, or already owning property, 2025 is the perfect time to get ahead of the game and take full advantage of this permanent tax benefit while it’s in effect.

Cost segregation is no longer just for large portfolios. Thanks to updated IRS guidance and broader access to qualified professionals, investors at every level can benefit.

Done right, this could be one of the most valuable tax strategies you use in 2025.

FAQs

Do I have to use bonus depreciation?

No, you are not required to use bonus depreciation. You have the option to opt out and choose an alternative method, such as straight-line depreciation or another form of accelerated depreciation, based on your overall tax strategy and financial goals.

Can I use cost segregation on flips?

No. Flipped properties are treated as inventory, not depreciable investment assets.

Is cost segregation worth it for small properties?

Usually, it’s most cost-effective for properties valued over $500,000, but exceptions exist, especially for STRs with high passive income.

Is bonus depreciation really 100% in 2025?

Yes. The new tax law officially reinstated 100% bonus depreciation for qualified property placed in service in 2025.

Get Professional Help

Cost segregation studies should always be conducted by experts, as DIY cost segregation can lead to errors, missed deductions, or IRS compliance issues. At INVESTOR FRIENDLY CPA®, our clients work with several reputable cost segregation providers who guide them through the process from start to finish, while our own tax specialists ensure full IRS compliance, detailed reporting, and maximum tax savings.

Let’s unlock hidden value in your real estate.

Watch our Cost Segregation Explained video

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