Updated · Part of the CRE investment glossary
How cost segregation works
Under MACRS, a building is depreciated on a straight line over 27.5 years if it is residential rental property and 39 years if it is nonresidential real property (Internal Revenue Code §168; IRS Publication 946). Land is not depreciable. Without a study, everything allocated to the building lands in one of those two buckets.
A cost segregation study identifies the parts of the price that are not the building structure: personal property such as appliances, carpeting, cabinetry and some dedicated electrical (often 5- or 7-year §1245 property), and land improvements such as paving, landscaping and site lighting (often 15-year property). Those parts are depreciated faster. Which items qualify, and in which class, is a fact question the study has to support — ask your CPA.
Bonus depreciation and the 2025 change
Property with a recovery period of 20 years or less can qualify for the additional first-year depreciation deduction under §168(k), usually called bonus depreciation. The One Big Beautiful Bill Act made it a permanent 100% for qualified property acquired after January 19, 2025, and the IRS set out the rules in Notice 2026-11. Property treated as acquired before January 20, 2025 — a written binding contract signed earlier counts — stays on the old phase-down, and taxpayers can elect a lower rate for the transition year.
Bonus depreciation is what makes a study large in year one. The reclassified 5-, 7- and 15-year property can be deducted in full the year it is placed in service, while the structure stays on 27.5 or 39 years. Qualified property can include certain used property, which matters for acquisitions; the eligibility details are for your CPA.
The formula
A simplified first-year view, when the reclassified property qualifies for bonus depreciation:
Year-1 depreciation ≈ (short-life basis × bonus %) + (remaining building basis ÷ recovery period)
- Short-life basis: the 5-, 7- and 15-year property the study identifies.
- Bonus %: 100% for qualified property acquired after January 19, 2025, unless the taxpayer elects out or elects the lower transition rate.
- Remaining building basis ÷ 27.5 or 39: straight line on the structure; the mid-month convention trims the first year.
Worked example: a $10,000,000 apartment purchase
A partnership buys an apartment building for $10,000,000. The land is valued at $2,000,000, so $8,000,000 is depreciable. A study reclassifies $2,000,000 of it — $1,200,000 of 5- and 7-year property and $800,000 of 15-year land improvements — and that property qualifies for 100% bonus depreciation. Figures are simplified: a full year of straight line, no mid-month convention.
The study moves about $1.9 million of deductions into year one ($2,218,182 − $290,909 = $1,927,273). Total depreciation over the life of the property is the same $8,000,000; only the timing changes.
| Line | No study | With study, 100% bonus |
|---|---|---|
| Building basis (27.5-year) | $8,000,000 | $6,000,000 |
| 5-, 7- and 15-year basis | $0 | $2,000,000 |
| Building depreciation (basis ÷ 27.5) | $290,909 | $218,182 |
| Bonus depreciation | $0 | $2,000,000 |
| Year-1 depreciation | $290,909 | $2,218,182 |
What to watch for
A study changes when you deduct, and that has consequences later:
- Recapture on sale: gain on the reclassified §1245 property is ordinary income up to the depreciation taken, and the building carries unrecaptured §1250 gain taxed at up to 25%.
- Losses investors cannot use yet: syndication investors receive the deduction on their K-1, but basis, at-risk and passive activity rules decide whether they can use it this year.
- Study quality: the IRS Cost Segregation Audit Techniques Guide (Publication 5653) expects a study to classify each asset, explain the legal basis for §1245 or §1250 treatment and reconcile allocated cost to actual cost. "Rule of thumb" studies with little documentation are the weakest.
- Buildings you already own: a study can be done years later; it is usually put into effect through an accounting method change on Form 3115 — ask your CPA.
- Short holds: if you sell within a few years, much of the benefit is a deferral that comes back at sale.
Primary sources
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.