What is a cost segregation study?
A cost segregation study is an engineering-based analysis that breaks the cost of a building into its components. Parts that are personal property or land improvements get shorter recovery periods than the building itself, so more depreciation lands in the early years.
Without a study, most of a rental's purchase price, after taking out the land, is depreciated in a straight line over 27.5 years for residential property or 39 years for commercial property. Land is never depreciated.
A study identifies items that are really 5 or 7 year property, such as appliances, certain flooring, cabinetry and furniture, and 15 year land improvements, such as driveways, fencing, landscaping and outdoor lighting. Per IRS Publication 946, these classes have their own recovery periods.
How does bonus depreciation work with cost segregation?
Bonus depreciation lets you deduct the full cost of qualifying property with a recovery period of 20 years or less in the first year. Per IRS guidance on the 2025 law, 100 percent bonus applies to qualifying property acquired after January 19, 2025, and it is now permanent.
The building itself does not qualify for bonus depreciation. The 5, 7 and 15 year parts a study identifies do. That is why the two work together: the study creates the short-life property, and bonus depreciation lets you deduct it at once.
Property acquired before January 20, 2025 follows the older phase-down percentages, so the purchase date matters. You can also elect out of bonus depreciation by class of property if spreading the deduction works better for you.
Is a cost segregation study worth it?
It depends on the building's cost, how long you plan to hold it, and whether you can actually use the loss this year. A study has a fee, and an accelerated deduction you cannot use only creates a suspended loss.
| Situation | Usually a fit | Usually not a fit |
|---|---|---|
| Property cost | Higher-cost buildings with a lot of contents and site work | Lower-cost properties where the fee eats the benefit |
| Your tax position | Losses are usable now: STR with material participation, REPS, or passive income to offset | Losses would be suspended for years |
| Holding period | You plan to hold for several years | You plan to sell soon |
| Timing | Year of purchase, or a catch-up year | Very late in the holding period |
Can I use cost segregation on a property I bought years ago?
Yes. You can do a study on property you already own and claim the missed depreciation in the current year as a single catch-up adjustment, using Form 3115 for a change in accounting method. You generally do not need to amend prior returns.
The catch-up uses the bonus rules that applied when the property was placed in service, not today's rules. A rental placed in service in 2023, for example, used that year's lower bonus percentage. Run the numbers before ordering a look-back study.
Can rental losses from cost segregation offset my other income?
Only in certain cases. Rental losses are passive by default and can only offset passive income. They become usable against wages or business income if you qualify as a real estate professional and materially participate, or if the property is a short-term rental with a 7 day average stay and you materially participate.
See our posts on the short-term rental loophole and real estate professional status for a spouse. Passive losses you cannot use now are not lost; they carry forward and are generally released when you sell the property in a taxable sale.
What happens when I sell?
Depreciation you took generally comes back. Gain on the 5, 7 and 15 year components is taxed as ordinary income up to the depreciation claimed, and depreciation on the building itself is taxed at up to 25 percent.
A sale also releases suspended passive losses, which can soften the hit. If you plan to keep investing, a 1031 exchange can defer the gain, including the recapture, as long as you replace the property correctly. Some states also do not follow federal bonus depreciation, so your state deduction may be spread out over more years.
Next step
We decide on cost segregation with a projection: what the study costs, what it saves and whether you can use the loss. See our pages for real estate investors and short-term rental owners. We work with rental owners nationwide. Book a free discovery call to talk it through.
Frequently asked questions
Does land qualify for depreciation or bonus depreciation?
No. Land is never depreciated. Land improvements such as driveways, fencing and landscaping are 15 year property and can qualify for bonus depreciation.
Can I do cost segregation myself?
The IRS expects a study to be well documented, and engineering-based studies hold up best. A rough percentage applied without support is a common audit issue.
Does cost segregation work on a primary residence?
No. Depreciation applies only to property used in a business or held to produce income, such as a rental. A home office or a rented part of a home may be different.
When does depreciation start on a new rental?
When the property is placed in service, meaning ready and available for rent, not the closing date.
What is depreciation recapture?
When you sell, the gain attributable to depreciation you claimed is taxed at ordinary rates for personal property components and at up to 25 percent for the building.