When a Cost Segregation Study Is Not Worth It: A Worked Example

A study moves depreciation into earlier years. That only helps if you can use the deduction and keep the property long enough for the timing to matter. This article walks through a case where it often does not help, then lists the other situations to watch for.

This is general education, not tax advice. Your CPA should confirm how the rules apply to you. For the full background, see the complete guide to cost segregation.

The scenario

• Purchase price: $400,000 for a long-term rental house
• Land allocation: $80,000
• Depreciable basis: $320,000
• Acquired after January 19, 2025, so 100% bonus depreciation applies to qualifying property
• The owner earns $300,000 in wages
• The owner has no other passive income
• The owner is not a real estate professional and plans to sell in about two years

The math before limits

Without a study, $320,000 over 27.5 years is about $11,600 per year.

If a study moves 25% of the basis, or $80,000, into 5, 7 and 15-year property, year-one depreciation is about $80,000 plus $240,000 over 27.5 years, or about $88,700. That is about $77,100 more than the baseline.

At a 32% bracket that looks like roughly $24,700 of tax savings.

Why it does not work here

The loss is passive and the owner is above the phase-out. The $25,000 allowance for active participants phases out between $100,000 and $150,000 of modified adjusted gross income. At $300,000 the allowance is gone. With no passive income to absorb it, the extra depreciation does not reduce tax this year. It becomes a suspended passive loss that carries forward. The sale is soon. When the owner sells in a fully taxable sale, suspended passive losses are generally released and can offset the gain. That means the deduction is not lost. But the gain on the shorter-life property is generally recaptured as ordinary income, up to the depreciation claimed, so the release can largely offset it. The result can be close to a wash, and the study fee is the net cost. What the owner gets: roughly nothing in year one, a deferred offset at sale, and a study fee. A study would have been better timed for a property held longer, or for a year when the owner has passive income or qualifies as a real estate professional.

Other situations to check

• Small basis. If the building basis is low, the first-year benefit may not cover the cost. Check the numbers in the calculator first.
• Low tax bracket now, higher later. Deductions are worth more in a higher bracket. See is cost segregation worth it?.
• Very short hold. Recapture arrives quickly, so the deferral benefit is small. Read depreciation recapture.
• State tax. Some states do not follow federal bonus depreciation, which shrinks the benefit.
• A 1031 exchange or long hold planned. These can defer recapture and strengthen the case for a study.

What to do instead

If the study does not fit this year, you can usually do it later. A look-back study with Form 3115 can claim missed depreciation in a future year. See how to file Form 3115 and look-back studies. Waiting until you have passive income, or until your status changes, may produce a better result.