Rental Owners’ Guide to Cost Segregation Savings

Maximize your rental property returns with cost segregation—a tax strategy that accelerates depreciation deductions to increase cash flow. Whether you own short-term or long-term rentals, this approach can help you reduce taxes and reinvest in your properties.

What Is Cost Segregation?

Cost segregation is an IRS-approved study that breaks down your property into components with shorter "useful lives" for faster depreciation. Instead of depreciating the entire building over 27.5 years, items like furniture, appliances, flooring, and land improvements (e.g., parking pads, fencing) can be written off over 5, 7, or 15 years. This front-loads deductions, putting more cash in your pocket to fund upgrades or acquisitions.

In 2025, assets acquired after January 19 and placed in service qualify for 100% bonus depreciation if their recovery period is 20 years or less. Assets placed in service earlier in 2025 may qualify for 40% bonus depreciation under transitional rules.

Why It Matters for Rental Owners

Standard depreciation for residential rentals spans 27.5 years, leaving money on the table. Cost segregation identifies assets eligible for faster write-offs, significantly boosting first-year deductions. For short-term rentals with average stays of 7 days or less, accelerated deductions may offset nonpassive income if you materially participate, amplifying tax savings.

Real-World Examples

Example 1: Long-Term Rental Duplex

• Purchase Price: $600,000

• Land Allocation: $120,000

• Depreciable Basis: $480,000
  

A cost segregation study reclassifies 25% ($120,000) as 5-, 7-, or 15-year assets, fully deductible in 2025 with bonus depreciation. Add $13,091 from the remaining building basis, and your first-year deduction is ~$133,091—versus ~$17,455 without a study. That’s an extra $115,600 in tax savings.

Example 2: Furnished Short-Term Rental

• Total Cost: $950,000

• Land: $150,000

• Depreciable Basis: $800,000

A study reallocates 30% ($240,000) to short-life assets, fully deductible in 2025. The remaining $560,000 yields ~$20,364 in standard depreciation. Total first-year deduction: ~$260,364, compared to ~$29,091 without a study—a $231,273 boost.

Key Benefits

• Accelerated Depreciation: Shift assets to shorter recovery periods, often fully deductible in 2025.

• Increased Cash Flow: Larger deductions lower taxes, freeing up funds for repairs, amenities, or new investments.

• Strategic Tax Savings: Short-term rental owners may offset nonpassive income, enhancing tax benefits with proper participation.

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Tips to Maximize Benefits

• Timing Matters: Ensure assets are acquired and placed in service after January 19, 2025, for 100% bonus depreciation, or earlier for 40% under transitional rules.

• Use a Quality Study: Hire professionals following IRS Cost Segregation Audit Techniques Guide standards for defensible documentation.

• Look-Back Studies: For existing properties, use Form 3115 to claim missed depreciation in the current year without amending prior returns.

• Track Participation: For short-term rentals, log hours to qualify for nonpassive treatment and maximize deduction benefits.

• Plan for Recapture: Accelerated deductions may increase depreciation recapture upon sale, so strategize with your advisor.

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Common Questions

• Is it only for large investors? No, single-family, small multifamily, and furnished short-term rentals often benefit, especially post-renovation.

• Does it work for existing properties? Yes, look-back studies can capture missed deductions in the current year.

• What qualifies for faster depreciation? Furniture, appliances, carpet, specialty lighting, and land improvements like fencing.

• Is it IRS-compliant? Yes, with a proper engineering-based study adhering to IRS guidelines.

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Next Steps

While we don’t perform cost segregation studies, our team at Host Extraordinaires can guide you through the process, model potential savings, and connect you with trusted professionals to execute a study. Contact us to optimize your rental’s tax strategy and turn depreciation into cash flow in 2025.