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Cost Segregation on Rent-Stabilised Buildings

Cost Segregation on Rent-Stabilised Buildings: The Lever RSO Owners Forget

by Stephen Morris CPA, MBT, CCIM

If your building is covered by the Los Angeles Rent Stabilization Ordinance, the city controls your revenue. It does not control your tax bill.

Cost segregation allows you to bring depreciation deductions forward. With 100% bonus depreciation now permanent for property acquired after January 19, 2025, the first-year deductions are the strongest they have been in years.

For a building where you cannot freely raise rents, this is one of the few remaining levers that can materially improve cash flow.

What a Cost Segregation Study Actually Does

A residential building is normally depreciated over 27.5 years. However, a building is not simply one asset.

Flooring, appliances, cabinetry, certain electrical and plumbing components, and site improvements such as paving and landscaping may qualify as shorter-life property depreciated over 5, 7 or 15 years.

A cost segregation study identifies and documents these components, allowing you to deduct their cost more quickly rather than spreading the deductions over nearly three decades.

For qualifying short-life property, bonus depreciation may allow the entire deduction to be taken in the first year.

Why Rent Stabilisation Makes It More Valuable, Not Less

Some owners assume that cost segregation is only worthwhile for trophy assets. That is backwards.

When rents are capped, your pre-tax return is largely fixed. The version of the return you can still improve is the after-tax return.

Accelerating depreciation can convert taxable income into cash that you can use now—for a seismic retrofit, a new roof or the purchase of your next building.

The Honest Part: Can You Use the Losses?

A large depreciation deduction will often create a paper loss. The passive-loss rules determine whether you can use that loss against your other income in the current year.

Real estate professional status may allow you to do so. Having other passive income that can absorb the loss may also help.

If neither applies, the loss is not necessarily wasted. It generally carries forward and may be released when the property is sold.

This is the analysis that should be completed before paying for a cost segregation study, and it is the first step in our process.

The Other Honest Part: Depreciation Recapture

Depreciation claimed now may be subject to recapture when the property is sold.

That is not necessarily a reason to avoid the strategy. A dollar saved today is generally more valuable than a dollar saved in 2040, and strategies such as a 1031 exchange or holding the property until death may defer or eliminate some of the recapture consequences.

However, recapture should be considered in the exit plan from day one rather than appearing as an unexpected issue during escrow.

Why Work With Us?

A cost segregation study is only as valuable as the assets it identifies.

We hold a general contractor’s licence and build multifamily properties ourselves. That means we understand what is inside the walls of a Los Angeles building and what those components cost.

Before you spend money on a study, we will tell you whether your building and your income position are likely to justify it.

Does Cost Segregation Increase My Property Taxes?

No. Cost segregation is an income tax strategy. It does not affect your property’s assessed value.

Is It Worthwhile for a Smaller Building?

Often, yes.

The answer depends more on your income and tax position than on the size of the building. We run the numbers before you pay anyone for a study.

I Have Owned the Building for Years. Is It Too Late?

No.

Missed depreciation can often be caught up in the current tax year through an accounting-method change, without amending previous returns.

Does an RSO Building Qualify in the Same Way as Any Other Property?

Yes.

The ordinance limits your rents, not your depreciation deductions.

Own an RSO Building?

Have us run the numbers first.

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