At a glance
- What it is
- An engineering-based study that reclassifies parts of a building into 5, 7, and 15-year property, which can then take 100% bonus depreciation.
- What it saves
- Income tax now, by moving depreciation from later years into the year the property is placed in service.
- Best fit
- Rental and commercial property owners.
- Main catch
- Rental losses are often passive and may only offset passive income, unless you qualify under the short-term rental or real estate professional rules.
- Bonus rate
- 100% for qualifying property acquired after January 19, 2025.
Key takeaways
- A cost segregation study reclassifies parts of a building into 5, 7, and 15-year property that can take 100% bonus depreciation in year one.
- It fits rental and commercial property owners, especially on purchases or construction of several hundred thousand dollars or more.
- In the illustrative $1,000,000 rental, the study adds about $192,727 of first-year depreciation, worth about $61,673 in federal income tax if the loss is usable.
- The catch: rental losses are often passive, and it's mostly a timing benefit, since reclassified property is generally taxed as ordinary income at sale.
The numbers
Picture an investor who buys a residential rental for $1,000,000, with $200,000 allocated to land, which can’t be depreciated. That leaves $800,000 of building cost. Suppose the cost segregation study reclassifies 25% of it, within the 20–30% range often seen.
For illustration purposes. Tax law may change, which may change these calculations slightly.
| No study | With study | |
|---|---|---|
| Reclassified to 5, 7, and 15-year property: 25% × $800,000 | $0 | $200,000 |
| Bonus depreciation on reclassified property (100%) | $0 | $200,000 |
| Regular depreciation on the rest over 27.5 years | $29,091 ($800,000 ÷ 27.5) | $21,818 ($600,000 ÷ 27.5) |
| Year-one depreciation (full-year figures) | $29,091 | $221,818 |
The study adds about $192,727 of first-year depreciation ($221,818 − $29,091). If the owner can use the loss against other income, at a 32% federal bracket that is worth about $61,673 in federal income tax this year ($192,727 × 32%). Actual first-year depreciation on the building portion is lower, since it is prorated by the month the property is placed in service.
The Oklahoma effect depends on whether Oklahoma follows federal bonus depreciation for the year, which we confirm before counting on it. Personal and business tax stay separate: if the property is held in a partnership or S corp, the depreciation is claimed on the entity’s return and flows to the owners.
This is mostly a timing benefit. The deductions you take now aren’t available later, and much of the reclassified property is taxed as ordinary income when you sell. The value comes from having the money now and from using it in a high-bracket year.
Could this strategy work for your business?
In a free tax analysis, your tax strategist checks whether it fits and what it could save, using your real numbers.
How it works
- Buy, build, or improve a property. The study works best in the year the property is placed in service.
- Order a cost segregation study. An engineering firm identifies components such as flooring, cabinetry, specialty electrical, landscaping, and paving, and assigns them shorter lives.
- Take bonus depreciation. The 5, 7, and 15-year property qualifies for 100% bonus depreciation in year one if it was acquired after January 19, 2025.
- Depreciate the rest normally. The remaining building cost is depreciated over 27.5 years for residential rentals or 39 years for commercial property.
Who it fits
- Rental and commercial property owners, especially on purchases or construction of several hundred thousand dollars or more, where the study cost is easily covered.
- Owners who qualify as real estate professionals, or who materially participate in a short-term rental, so the losses can offset other income.
- Owners with passive income from other rentals that the losses can absorb.
When it doesn’t fit
- Small properties where the study costs more than it saves.
- Owners whose losses would be passive and suspended for years with no passive income to use them against.
- Properties likely to be sold soon, when recapture would quickly reverse much of the benefit.
The rules
- Bonus depreciation. The July 2025 federal tax law restored 100% bonus depreciation permanently for qualifying property acquired after January 19, 2025. Used property can qualify if you didn’t use it before.
- Passive loss rules. Rental losses are generally passive. A $25,000 allowance for active participants phases out between $100,000 and $150,000 of modified AGI.
- Real estate professional. More than 750 hours a year and more than half of your working time in real property businesses, plus material participation in the rentals.
- Short-term rentals. If the average guest stay is 7 days or less and you materially participate, the rental generally isn’t treated as a passive rental activity.
- Look-back studies. Property placed in service in earlier years can still be studied, with the missed depreciation caught up through an accounting method change (Form 3115). The bonus rate depends on when the property was acquired.
Risks to weigh
- Recapture. When you sell, depreciation on the reclassified property is generally taxed as ordinary income, and building depreciation at up to 25%.
- Weak studies. The IRS expects an engineering-based study with detailed support. A rough percentage estimate won’t hold up.
- Overstated participation. Real estate professional and short-term rental claims are frequently examined. Keep a contemporaneous log of hours.
- Other loss limits. Large losses can also run into limits on excess business losses.
How we handle it for clients
With a Cannon & Brown tax plan, we test whether a study will pay off before you order one, check whether your losses will be usable this year, coordinate with the study provider, and track the depreciation and future recapture so a sale doesn’t bring surprises. Because our technology keeps your numbers current all year, we can test this strategy against your real numbers and adjust it as your business changes.
Illustrative example. The investor and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes a $1,000,000 residential rental acquired after January 19, 2025, $200,000 allocated to land, 25% of the building reclassified, full-year depreciation figures, losses that are fully usable, and a 32% federal bracket. This page is educational and is not tax advice for your situation; tax rules and limits change.
Brooks leads Cannon & Brown Tax Advisors, a forward-thinking tax firm serving business owners in Oklahoma and beyond. He builds year-round tax strategies that help business owners keep more of what they earn and reach their goals. More about Brooks
Common questions about cost segregation
Can I do a cost segregation study on a property I bought years ago?
Yes. Property placed in service in earlier years can still be studied, with the missed depreciation caught up through an accounting method change on Form 3115. The bonus rate depends on when the property was acquired.
Can cost segregation losses offset my W-2 or business income?
Only in certain cases. Rental losses are generally passive, but owners who qualify as real estate professionals, or who materially participate in a short-term rental, may use them against other income.
Is a cost segregation study worth it on a small rental?
Often not. On small properties the study can cost more than it saves, and it usually pays off best on purchases or construction of several hundred thousand dollars or more.
What happens to cost segregation deductions when I sell the property?
They're largely recaptured. Depreciation on the reclassified property is generally taxed as ordinary income, and building depreciation at up to 25%, so properties likely to be sold soon are a poor fit.
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