The Cost Segregation Study: What STR Investors Need To Know (2025)

Rental Property Depreciation is a killer strategy for reducing taxes.

And short-term-rental (STR) owners need a cost segregation study to reclassify parts of their property from a standard 39-year life to shorter lifespans (say, 5 or 15 years.)

Even as bonus depreciation phases out to 0 percent by 2027, a cost segregation study can still maximize your property’s depreciation benefits.

Let’s take a closer look.

How to Use Rental Property Depreciation to Your Advantage

Rental property depreciation can be a game-changer when it comes to reducing taxes for your short-term rental (STR) business. 

By leveraging strategies like accelerated depreciation, you can take larger deductions in the early years of owning a property, freeing up cash flow and lowering your tax bill. Here’s how it works and why it’s worth considering.

What Is Accelerated Depreciation?

Accelerated depreciation allows assets to lose value more quickly in the earlier years of ownership, rather than spreading the deductions evenly over the property’s lifespan.

Why does this matter?

• Bigger tax savings earlier on: You can claim larger deductions in the first few years the property is in service.
• Lower taxable income: Reducing your reported profit means you may qualify for a lower tax bracket.
• Improved cash flow: With a lower tax bill, you can reinvest savings into your business or other opportunities.

How Does A Cost Segregation Study Fit In?

The IRS typically allows residential rental properties to depreciate over 27.5 years and commercial properties over 39 years. However, not every part of a property needs to follow this timeline.

Look at it this way. When you buy or construct a property, it includes more than just the building itself. Think about:

• Plumbing fixtures
• Carpeting
• Sidewalks
• Fencing
  

If purchased separately, these items could be depreciated over 5, 7, or 15 years. A cost segregation study helps identify these shorter-life assets and accelerates their depreciation, giving you more tax savings upfront.

How Does a Cost Segregation Study Work?

A cost segregation study breaks down the purchase price or construction cost of your property into categories with different depreciation schedules. Here’s the process:

1. Identify short-life components: Examples include electrical outlets for appliances (5 years) or landscaping improvements (15 years).
2. Reallocate costs: On average, 20-40% of a property’s components can qualify for accelerated depreciation.
3. Calculate tax savings: By writing off these assets sooner, you significantly reduce your taxable income in the early years.

What’s Involved in a Cost Segregation Study?

A high-quality cost segregation study includes:

• Review of property records: Cost details, blueprints, and other documentation.
• On-site inspection: To identify and assess qualifying components.
• Comprehensive reporting: Detailed findings with a breakdown of depreciation categories.
  If records are incomplete, professionals can still estimate values based on the property inspection.

When Should You Conduct a Cost Segregation Study?

Timing matters!

• Best time: The year a property is purchased, remodeled, or constructed.
• Planning ahead: If you’re building or renovating, consider a study before finalizing the infrastructure.
  For STR investors, acting early ensures you maximize your deductions as soon as the property is in service.

How Much Can You Save?

Let’s crunch the numbers with an example:

Imagine you own a short-term rental valued at $800,000.

Without cost segregation:

• Depreciate over 39 years: $20,512 per year
• Tax savings (at 37% rate): About $4,600/year
  

With cost segregation:

• $100,000 of electrical fixtures (5 years)
• $100,000 of plumbing fixtures (7 years)
• $100,000 for parking, landscaping and storm sewers (15 years)
  

Now, instead of a flat $800,000 depreciating over 39 years, you allocate $300,000 for accelerated depreciation. This leads to significantly larger tax savings in the first year and beyond.

DIY Cost Segregation Studies—Are They Worth It?

While you can identify some short-life assets on your own, working with a tax professional ensures you get the full benefit of a cost segregation study.

There are two main approaches:

• “Rule of thumb” method: Estimates based on similar properties; less reliable and higher risk.
• Engineering approach: A detailed review using actual cost records; more accurate and preferred by the IRS.
  A professional specializing in cost segregation will typically use the engineering approach, reducing your audit risk and maximizing your tax savings.

Bonus Depreciation is Phasing Out: Act Now to Maximize Savings

Rental property depreciation, especially when paired with a cost segregation study, is a powerful tool for STR investors. By accelerating depreciation on certain components, you can:

• Free up cash flow
• Lower your taxable income

Reap significant tax savings in the early years of ownership

As the saying goes, all good things must come to an end. Under current law, bonus depreciation is being phased out:

• 2024: Reduced to 60%
• 2025: Drops to 40%
• 2026: Down to 20%
• 2027 and beyond: Completely eliminated (0%)

If you’re an investor looking to take advantage of this tax-saving strategy, now is the time. The sooner you act, the greater your potential savings before bonus depreciation disappears entirely. 

Want to unlock these benefits? Reach out to a tax professional to see if a cost segregation study is right for your property. The savings could be substantial, so don’t miss this window of opportunity to optimize your cash flow and reduce your tax burden!

BONUS: 12 Common Questions About Cost Segregation Studies

1. What Is a Cost Segregation Study?

Every property is made up of a variety of assets, and each one has a different expected useful life. For instance, tile flooring is much more durable than carpet, right? 

Tax law accounts for these differences and guides how capital expenditures should be depreciated. Using the Modified Asset Cost Recovery System (MACRS):

• Residential real property is typically depreciated over 27.5 years.
• Nonresidential real property is depreciated over 39 years.
  Without a cost segregation study, all assets in a property would default to these timelines, even though it doesn’t make sense for shorter-lived components like carpet. Cost segregation adjusts this, giving you more accurate depreciation timelines—and better tax savings.

2. How Are Building Assets Categorized for Depreciation?

A cost segregation study breaks down a property into individual components, assigns costs to each using IRS-approved pricing guides, and places them into different categories based on their depreciation timelines. Here are some common categories:

• 5-Year Assets: Carpet, countertops, cabinetry, decorative moldings, specialty lighting, dedicated outlets, fire extinguishers.
• 7-Year Assets: Office furniture.
• 15-Year Assets: Land improvements like parking lots, landscaping, drainage systems, outdoor pools, and sidewalks.
  By moving these assets into shorter-lived categories, they depreciate faster, which means more tax savings upfront and better cash flow.

3. Is Cost Segregation Worth It For Rental Property Investors?

Yes, cost segregation can offer a significant return on investment! While the cost of the study depends on the size and complexity of the property, the benefits often far outweigh the expense. Beyond accelerated depreciation, cost segregation can:

• Provide data for future tax strategies.
• Be updated if new tax laws or opportunities arise.
  To get a clearer picture of potential savings, many providers offer free estimates after reviewing your property details.

4. What Types of Real Estate Qualify for Cost Segregation?

Cost segregation isn’t just for office buildings or hotels—it can be applied to nearly all types of commercial and residential real estate, including short-term rentals. Popular property types include:

• Garden-style apartment complexes
• Manufacturing facilities
• Auto dealerships
• Self-storage facilities

5. Does Cost Segregation Create New Deductions?

No, cost segregation doesn’t create new deductions. Instead, it accelerates existing deductions by shifting them to earlier years of ownership. This lets you take advantage of the time value of money by getting tax savings sooner.

6. Can I Do a Cost Segregation Study Myself?

While cost segregation may seem straightforward, a quality study requires expertise. A professional will conduct a detailed forensic analysis of the property, breaking out assets, assigning costs, and ensuring compliance with IRS rules. This level of precision is key to maximizing your tax savings and minimizing audit risks.

7. When Is the Best Time to Perform a Cost Segregation Study?

The best time to perform a cost segregation study is right after a property is purchased or constructed. This ensures the study accurately reflects the assets in place when the property is first put into service, maximizing your tax benefits from day one.

8. How Far Back Can You Do a Cost Segregation Study?

You can conduct a “look-back” cost segregation study for properties purchased in previous years. This allows you to claim missed depreciation without amending past tax returns by filing Form 3115 to catch up on deductions.

9. Can Cost Segregation Studies Be Used as a Planning Tool?

Absolutely! Cost segregation can be integrated into your tax planning strategy before a property is purchased or constructed. For example, you can:

• Design buildouts to maximize assets eligible for accelerated depreciation.
• Incorporate energy-efficient features to qualify for additional credits like IRC Sec. 179D or Sec. 45L.
• Align depreciation deductions with cash flow needs.
  The data from a cost segregation study can also set you up for future tax benefits, such as partial asset dispositions or tracking capital improvements.

10. How Does Bonus Depreciation Relate to Cost Segregation?

Bonus depreciation allows you to take an additional write-off for assets with a class life of less than 20 years. It’s a powerful tool that complements cost segregation, as the study identifies assets eligible for bonus depreciation. Under the Tax Cuts and Jobs Act, the bonus depreciation rate was 100% for assets placed in service between 2017 and 2022. This rate dropped to 80% in 2023 and will phase out entirely by 2027. Despite the reduction, cost segregation still provides significant tax benefits.

11. Is Cost Segregation Useful for Renovation Projects?

Yes! While cost segregation is commonly used for newly purchased or constructed properties, it’s also valuable for properties undergoing major renovations. By quantifying and categorizing assets before they’re retired, you can take advantage of the partial asset disposition (PAD) election to write off the remaining value of disposed assets. Renovated assets classified as Qualified Improvement Property (QIP) may also qualify for accelerated depreciation or bonus depreciation.

12. What Is Qualified Improvement Property (QIP) and How Is It Connected to Cost Segregation?

QIP refers to interior improvements made to nonresidential buildings after they’ve been placed in service, excluding structural changes, expansions, or upgrades like elevators. Thanks to the CARES Act, QIP now has a 15-year recovery period, making it eligible for bonus depreciation. Cost segregation helps identify and categorize QIP assets, ensuring they are accurately valued for depreciation purposes. This is especially beneficial for landlords providing tenant buildout allowances, allowing for faster tax savings on these investments.