Should You Use Cost Segregation On A Single-Family Rental?

When you purchase a residential rental property, the IRS allows you to depreciate the building (not the land) over 27.5 years. That means you deduct a portion of the property’s value each year, even though you didn’t physically spend that money annually.

That annual deduction lowers taxable income, a major benefit of rental property. Cost segregation speeds up some depreciation.

Instead of treating the entire building as one 27.5-year asset, a cost segregation study breaks the property into components. Certain items, such as appliances, cabinetry, some flooring, lighting, site improvements, and portions of electrical or plumbing, may qualify for shorter depreciation lives, often five, seven, or fifteen years.

When those items are reclassified into shorter categories, you can deduct their value more quickly.

Where Bonus Depreciation Enters The Picture

Bonus depreciation allows certain qualifying property, typically those shorter-life assets identified in a cost segregation study, to be deducted more aggressively in early years. Depending on current tax law, this can significantly increase first-year depreciation.

This is why some investors report buying a property that cash flows and still generates a substantial tax loss in year one.

But a large deduction is only valuable if it offsets income you would otherwise pay taxes on. Without that income to offset, the benefit may be delayed or limited.

Why Single-Family Rentals Are A Different Conversation

Cost segregation is very common in large multifamily and commercial properties. The reason is simple: scale.

A large apartment complex has a much bigger building basis. That creates more opportunity for reclassification and more potential tax impact.

With a single-family rental, the numbers are smaller. The potential benefit may still exist, but it’s more sensitive to:

• Purchase price
• Allocation between land and building
• Your income level
• Your hold time
• The cost of the study
• How much depreciation can you actually use

A Good Idea For You Personally?

Cost segregation tends to make sense when the accelerated deductions meaningfully improve your current tax position.

For example, if you have high taxable income from a business, W-2 wages, or other investments, and you are eligible to use rental losses, accelerating depreciation may reduce your current tax liability.

The strategy can also make more sense when the property has a strong building basis. A higher purchase price or a significant renovation that increases the basis creates more opportunity for meaningful reclassification.

Cost segregation accelerates deductions, ideal if holding property long-term to boost early cash flow from tax savings. Investors with multiple properties coordinate with high-income years or liquidity events to maximize benefits.

When You Should Rethink The Strategy

If your income is too low, or passive activity rules prevent you from using rental losses, accelerated depreciation may create suspended losses that carry forward. In that case, you’ve paid for a study without unlocking immediate value.

It may also not make sense for lower-priced single-family properties where the cost of the study consumes a significant portion of the potential tax savings.

Short hold periods introduce another concern. Accelerating depreciation today may increase the amount of depreciation recapture when you sell. While the time value of money can still make acceleration beneficial, the trade-off must be clearly understood.

A Simple Example To Clarify The Concept

Assume you purchase a single-family rental for $400,000. After allocating land value, assume $320,000 is attributed to the building.

Under standard depreciation rules, that $320,000 would be depreciated over 27.5 years. That produces roughly $11,600 in annual depreciation.

Now imagine a cost segregation study reclassifies $80,000 of the building’s value into shorter categories, such as five- and fifteen-year property.

Those assets depreciate much faster. If bonus depreciation applies in that year, a significant portion of that $80,000 may be deducted early.

Instead of roughly $11,600 in year-one depreciation, you could see a much larger deduction.

The Recapture Question Investors Shouldn’t Ignore

One of the most misunderstood aspects of cost segregation is depreciation recapture.

When you sell a property, depreciation taken over the years can be subject to recapture tax. That does not automatically eliminate the benefit. Often, the time value of money makes earlier deductions more valuable than later ones. But the exit strategy matters.

If you plan to hold long-term, exchange under a 1031, or incorporate estate planning strategies, the recapture impact may look very different from what it would if you plan to sell in three years.

Strategy Over Headlines

Cost segregation can absolutely be a powerful tool. It can improve early cash flow. It can reduce taxes in high-income years. It can align with a broader portfolio growth strategy.

For single-family investors especially, the decision should come down to alignment, and if the answer to those questions is yes, cost segregation may deserve serious consideration:

• Does accelerating depreciation improve your actual after-tax return?
• Does it fit your income profile?
• Does it align with your hold timeline?
• Does it support your long-term portfolio strategy?

How Smart Investors Approach The Decision

Sometimes the answer is to accelerate depreciation. Sometimes the answer is to keep things straightforward and avoid unnecessary cost and complexity.

If you’re growing a single-family rental portfolio and want to understand whether cost segregation for a single-family rental could meaningfully improve your returns, especially in combination with bonus depreciation for rental property, we can help you think through the investment side of the equation.

We do not provide tax, legal, or accounting advice. But we can help you evaluate how the depreciation strategy interacts with your acquisition plan, hold timeline, portfolio growth goals, cash flow projection, and exit strategy.

If you’d like to walk through your numbers and determine whether this belongs in your strategy, reach out to Henderson Investment Group to schedule an investor tax strategy call!