Cost segregation and bonus depreciation

What the study actually does

A building bought as a single line item is not a single asset for tax purposes. The IRS Cost Segregation Audit Techniques Guide describes section 1250 property as "generally non-residential real property (with a 39-year recovery period) or residential rental property (with a 27.5-year recovery period)." That is the default treatment of the whole purchase price allocated to improvements.

A cost segregation study takes that single number apart. Carpet, cabinetry, appliances, specialty electrical serving equipment rather than the structure, decorative lighting, land improvements such as paving, fencing, site utilities and landscaping are not the building. They are shorter-lived property that happens to have been bought inside the building's price. A quality study, in the guide's words, "lists § 1245 property (including amounts) and shows any property originally classified as § 1250 property that is reclassified to § 1245 property."

The reclassified components typically fall into five, seven and fifteen year recovery classes rather than 27.5. On a garden-style multifamily asset the reclassified share is commonly a meaningful fraction of the improvement basis, though the actual figure is a function of the specific property and its finish level, and any sponsor quoting you a percentage before a study exists is quoting an expectation rather than a result.

Nothing here creates a deduction that did not exist. It changes when the existing deduction is taken. Everything else on this page follows from that one sentence.

Bonus depreciation, and what the law now says

Reclassification matters far more when the shorter-lived property can be written off immediately, and that is what bonus depreciation under section 168(k) does. The rule changed materially in 2025, and a great deal of material still in circulation describes the old regime.

The current position is set out in IRS Notice 2026-11, the interim guidance issued in January 2026. It records that section 70301 of the One, Big, Beautiful Bill Act "made several amendments to § 168(k) to provide taxpayers with a permanent 100 percent additional first year depreciation deduction for qualified property acquired and placed in service, and specified plants planted or grafted, after January 19, 2025." The same section "replaced the annual phasedown of the applicable percentage" that had been running down since 2023.

So the phase-down many investors were planning around is gone for property acquired after that date. For property that falls under the old regime instead, the notice records that the prior applicable percentage "is (i) 40 percent for qualified property placed in service during 2025."

The effect on a syndication is direct. The portion of the purchase price reclassified into five, seven and fifteen year property can be deducted in full in year one rather than over its recovery period. That is what produces the large first-year paper loss that appears on a projected K-1, and it is why sponsors talk about cost segregation and bonus depreciation as though they were one thing. They are not. Cost segregation identifies the property. Bonus depreciation determines how fast it can be written off.

There is also an election running the other way. The notice records that the Act amended section 168(k)(10) "to allow taxpayers to elect to deduct 40 percent ... instead of 100 percent" for qualified property placed in service during the first taxable year ending after 19 January 2025. A partnership might choose that, and if the deal you are in has made an election you should know about it, because it changes your K-1.

The written binding contract trap

The date that governs is the acquisition date, not the closing date, and the statute contains a rule that catches this out. Notice 2026-11 records that the Act "contains language similar to § 13201(h)(1) of the TCJA, stating that for purposes of the effective date ... property is not treated as acquired after the date a written binding contract is entered into for such acquisition."

Read against a real transaction, that means a property under a purchase and sale agreement signed on or before 19 January 2025 is treated as acquired on that earlier date, even if the deal closed months later. It therefore sits under the old phasedown at 40 percent rather than the permanent 100 percent, and a projection built on the assumption of full bonus would be materially wrong.

The window is narrowing as time passes, and for anything contracted well after January 2025 the question does not arise. It still arises for assets acquired out of a contract signed in that period, for certain assumptions of existing contracts, and it is a question you can ask in one line: on what date was the written binding contract for this property entered into, and what applicable percentage does the projection assume?

This is the kind of detail that separates a projection someone has actually computed from one that has been copied forward. A sponsor who has run the analysis will answer immediately.

It is a deferral, and the bill arrives on sale

Accelerating depreciation does not increase the total deduction available over the life of an asset. It moves deductions forward. The entire benefit is the time value of taking a deduction in year one rather than spreading it across 27.5 years, and that benefit is real, but it is a financing benefit rather than a reduction in lifetime tax.

Two mechanisms take it back. Depreciation of any kind reduces your basis, so the gain on sale is correspondingly larger. And the accelerated portion is subject to recapture, with the section 1245 property that a study creates recaptured as ordinary income to the extent of depreciation taken rather than at capital gain rates. Reclassifying property into section 1245 therefore converts part of your eventual gain from capital to ordinary.

The practical consequence is that a deal can show an attractive first-year loss and a heavier than expected tax bill in the exit year. Neither is a surprise if both are modeled. Investors are usually shown the first and rarely shown the second.

Whether the trade is worth making depends on your own marginal rate now against your expected rate at exit, your holding period, and what else is on your return. Those are facts about you. We are not licensed to weigh them, and any sponsor telling you the answer without knowing your return is not giving you tax advice, they are giving you a sales pitch. The general framework for depreciation sits in IRS Publication 946.

The procedural step most decks omit

A study performed after the year of acquisition is not simply a recalculation. The IRS guide states that "a change in depreciation method, recovery period or convention ... constitutes a change in accounting method. Therefore, the use of a cost segregation study to reclassify property and/or reallocate costs requires the consent of the Commissioner."

In practice that consent is obtained through an application for change in accounting method on Form 3115, which for most cost segregation changes falls under an automatic consent procedure. It is a filing rather than a discretionary approval, but it is a filing, it has to be done correctly and on time, and it has a cost.

The distinction that matters to you is between a study done in the acquisition year, where the classification is simply adopted on the first return, and a look-back study on a property held for several years, which requires the method change and produces a catch-up adjustment. Both are legitimate. They are different pieces of work with different costs, and a sponsor should be able to tell you which one is contemplated and who is paying for it.

What a defensible study contains, in the IRS's own words

The guide sets out thirteen principal elements of a quality study. They are worth listing, because they are the checklist an examiner works from and therefore the checklist you can hold a sponsor to: "Preparation by an Individual with Expertise and Experience, Detailed Description of the Methodology, Use of Appropriate Documentation, Interviews Conducted with Appropriate Parties, Use of a Common Nomenclature, Use of a Standard Numbering System, Explanation of the Legal Analysis, Determination of Unit Costs and Engineering Take-Off, Organization of Assets into Lists or Groups, Reconciliation of Total Allocated Costs to Total Actual Costs, Explanation of the Treatment of Indirect Costs, Identification and Listing of § 1245 Property, and Consideration of Related Aspects."

On who should do the work, the guide is unusually direct, and the sentence deserves to be read twice: "The preparation of cost segregation studies requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes. Unfortunately, there are no prescribed qualifications for cost segregation preparers."

It goes on: "In general, a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background," while noting that cost estimating experience and knowledge of the applicable tax law also matter. And it sets an expectation you can test directly, because "a quality study identifies the preparer and always references their credentials, experience, and expertise in the cost segregation area."

That last line converts into a question with a verifiable answer. Ask who prepared the study, what their background is, and whether the report names them. A study that does not identify its own preparer has failed a standard the IRS wrote down.

Why the deduction may never reach you

This is the part that disappoints most investors, and it has nothing to do with the study being good or bad. Rental activity is generally passive, and passive losses offset passive income rather than wages, business income or portfolio income. The rules are in IRS Publication 925 and the computation runs through Form 8582.

If you have no passive income, a large first-year loss on your K-1 is generally suspended. It does not vanish, and it is not wasted, but it does not reduce this year's tax on your salary. It carries forward, and the publication describes disallowed deductions as being "allocated among your activities for the next tax year in a manner that reasonably reflects the extent to which each activity continues the loss activity."

There is a limited exception, and it is unlikely to help the investors this page is written for. The special allowance permits up to $25,000 of rental real estate loss against other income where you actively participated, but per the publication the maximum "is reduced by 50% of the amount of your modified adjusted gross income that is more than $100,000," so it is exhausted entirely at $150,000. An accredited investor is generally above that line by definition.

The other exception is real estate professional status, which requires both that "more than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated" and that "you performed more than 750 hours of services during the tax year in real property trades or businesses." A passive limited partner in a syndication is, by construction, not materially participating. If you or a spouse qualifies through other activity, the analysis changes completely, and that is a conversation for your CPA rather than for a sponsor.

What happens when the deal sells

Suspended losses are released on a fully taxable disposition of your entire interest in the activity. Publication 925 provides that on such a disposition the accumulated disallowed losses become deductible in that year, which is why a suspended loss is a deferral rather than a forfeiture.

That gives the arithmetic a shape worth understanding before you invest. In a typical passive limited partner position the accelerated deduction is suspended in year one, carries forward, and is then released in the exit year against the gain that the same accelerated depreciation helped create. The two events are connected, and looking at either alone gives a misleading picture.

The word doing the work is "entire." Partial dispositions, transfers by gift and transfers at death follow different rules, and a disposition to a related party may not release the losses. If your position may move for estate planning reasons before the deal exits, that is worth raising with your own advisers early rather than at the point of transfer.

Our position

Cost segregation is legitimate, well-documented in the IRS's own guidance, and worth doing on most multifamily acquisitions. It is also the most oversold feature in private real estate, and the overselling takes a consistent form: a large first-year number presented without the four qualifications on this page.

What we will tell you is whether a study is planned, who is expected to prepare it, what the acquisition date is for bonus depreciation purposes, what applicable percentage the projection assumes, and whether any election under section 168(k)(10) has been made. Those are facts about the deal and you are entitled to them.

What we will not tell you is what any of it is worth to you, because that depends on your marginal rate, your passive income, your holding period and your exit year, none of which we know and none of which we are licensed to assess. Take the numbers to your own CPA. The deductions are reported to you on a Schedule K-1, which is also the reason your return may need to go on extension.

What to ask about a study

1. On what date was the written binding contract for this property entered into?
2. What applicable percentage of bonus depreciation does the projection assume, and has any election under section 168(k)(10) been made?
3. Is a cost segregation study planned, who will prepare it, and does the report name their credentials?
4. Is this an acquisition-year study or a look-back study requiring a Form 3115?
5. Who pays for the study, and is that cost inside the deal or charged to investors separately?
6. What does the model assume about depreciation recapture in the exit year?

What this is built on

1. Internal Revenue Service, Notice 2026-11, interim guidance on the additional first year depreciation deduction under section 168(k)
2. Internal Revenue Service, Publication 5653, Cost Segregation Audit Techniques Guide
3. Internal Revenue Service, Publication 925, Passive Activity and At-Risk Rules
4. Internal Revenue Service, Publication 946, How To Depreciate Property
5. Internal Revenue Service, About Form 3115, Application for Change in Accounting Method
6. Internal Revenue Service, About Form 8582, Passive Activity Loss Limitations
7. Internal Revenue Service, About Form 4562, Depreciation and Amortization