When most people think about cost segregation, they picture new construction or a recently acquired building. But there’s a powerful, often overlooked opportunity: applying cost segregation to renovated properties. Whether you’re upgrading a commercial office, repositioning a multifamily asset, or doing tenant improvements, cost segregation can unlock significant tax savings, even if the building has been owned for years.
Why Renovations Present a Unique Opportunity
Renovations typically involve improvements to both personal property (think carpeting, millwork, fixtures) and real property (walls, HVAC systems, elevators). Cost segregation studies help separate these components for accelerated depreciation.
Under current tax law, most commercial real estate is depreciated over 39 years using straight-line depreciation. But many components added during a renovation, like cabinetry, specialty lighting, or updated plumbing, can be depreciated over 5, 7, or 15 years. By identifying and reclassifying these assets, a cost segregation study allows you to front-load deductions into earlier tax years, which improves cash flow and ROI.
What Renovations Qualify?
Not all renovations will benefit equally. Here are some examples of assets commonly reclassified:
Eligible for 5-Year Depreciation:
- Carpet and flooring
- Decorative lighting
- Millwork and cabinetry
- Removable Wall partitions (non-load-bearing)
Eligible for 15-Year Depreciation (land improvements):
- Landscaping and irrigation
- Parking lot resurfacing
- Outdoor lighting
- Sidewalks and fencing
What Doesn’t Qualify:
- Structural improvements
- Interior walls
- Painting
- Ceilings
- Roofing
- Enlargements of the building
However, just because a component is structural doesn’t mean it can’t trigger depreciation benefits through partial asset dispositions or retirement of replaced assets, two key strategies discussed below.
Real-World Examples of Renovated Properties
Example 1: Medical Office Renovation in Texas
An investor owns a 12,000-square-foot medical office building in Austin, TX. In 2024, they invest $650,000 in renovations to modernize the space for new tenants. Improvements include:
- Demolition and replacement of all flooring with medical-grade vinyl
- Installation of custom cabinetry and sinks in exam rooms
- New LED lighting and soundproof ceiling tiles
- Refreshed landscaping and parking lot sealcoat
A cost segregation study reclassified over $300,000 of the renovations into 5-year and 15-year property, allowing for accelerated deductions and significant year-one tax savings.
Example 2: Boutique Hotel Repositioning in Oregon
A real estate developer completed a $1.2 million renovation of a 30-room boutique hotel in Bend, OR. The scope included:
- New lobby millwork and front desk cabinetry
- Replaced guest room furniture, fixtures, and carpet
- Added a fire pit area with hardscape and lighting
- Renovated bathrooms with new vanities and decorative tile
The study identified approximately $500,000 in short-life assets, enabling substantial depreciation deductions within the first few years post-renovation.
Strategic Considerations for Renovated Properties
Here are three key strategies to optimize tax benefits through cost segregation after a renovation:
1. Perform a Post-Renovation Cost Segregation Study
If your renovation project involves multiple systems or improvements, such as flooring, cabinetry, lighting, and exterior work, it may be a strong candidate for cost segregation. This is especially true when the upgrades go beyond a single asset that could otherwise be added to the depreciation schedule manually.
A post-renovation study allows you to:
- Reclassify newly added components into shorter recovery periods
- Identify opportunities for bonus depreciation
- Maximize deductions in the current tax year
Even if a cost segregation study was already done at acquisition, a new study after improvements can uncover fresh depreciation opportunities.
2. Leverage Partial Asset Dispositions (PADs)
If you remove old components, say, demoing old drywall, flooring, or HVAC systems, you may be able to write off the remaining undepreciated basis of those assets. This is called a partial asset disposition, and it’s one of the most powerful yet underutilized tools in tax planning.
To claim this, you need:
- A clear audit trail of what was disposed
- Cost estimates or engineering analysis showing original values
When combined with a cost segregation study, PADs can double up the tax benefits: a write-off of the old asset and accelerated depreciation of the replacement.
3. Watch Out for the “Improvement Rule”
To qualify for bonus depreciation, improvements must be placed in service after the building was originally in service, but the improvement can’t be part of the building’s original construction. This means renovations done years later usually qualify. However, renovations done shortly after acquisition may not, especially if they were planned at the time of purchase.
Consult your tax advisor or engineering firm to determine eligibility.
When to Consider a Study
Cost segregation on renovated properties isn’t one-size-fits-all. Here’s when it makes sense to consider it:
- You replaced multiple building systems or tenant finishes
- You’re looking to enhance ROI and reduce tax liability
- You’re facing high current-year income and want to offset it
- You recently completed improvements but haven’t filed your return yet
Even if the renovation occurred in a prior year, you may still qualify by amending returns or filing Form 3115 for a change in accounting method.
The Bottom Line
Cost segregation is a proven strategy for accelerating depreciation and unlocking tax savings, but it doesn’t just apply to new buildings. Renovated properties, when properly analyzed, can provide even more strategic benefits through partial asset dispositions and new short-life classifications.
If you’ve invested heavily in improving a property, a post-renovation cost segregation study could transform how and when you realize those benefits.
Unlock the Full Tax Potential of Your Renovation
If you’ve recently completed a renovation or have one in the works, now is the time to explore how cost segregation can amplify your tax savings. Our team specializes in identifying hidden value in improved properties and turning upgrades into immediate deductions.
Let’s talk about what your renovation could be worth at tax time.
