A cost segregation study is an engineering-based analysis that breaks a property's purchase price into individual components, such as flooring, lighting, parking areas, and site improvements, and reclassifies them into shorter depreciation categories than the building's overall structure. Under standard tax rules, a commercial building depreciates over several decades, while items like carpeting, certain electrical systems, or landscaping can often be depreciated over five, seven, or fifteen years. Front-loading these deductions can meaningfully reduce taxable income in the early years of ownership, which matters most to investors seeking to offset other income.
Sponsors typically commission a cost segregation study shortly after acquiring a property, using a qualified engineering firm to allocate costs defensibly under IRS guidelines. The resulting depreciation schedule flows through to investors via Schedule K-1, though how much of that benefit an individual investor can use depends on their passive activity status and overall tax situation.
Further reading: Inside a Cost Segregation Study: How a Building Becomes a Tax Shield for Its LPs
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