Cost Segregation for Rental Properties: Accelerating Depreciation to Reduce Taxes
A cost segregation study reclassifies components of a rental property from the default 27.5-year depreciation schedule (residential) or 39-year (commercial) into shorter recovery periods: 5-year property (appliances, carpeting, decorative fixtures), 7-year property (office furniture, specialized equipment), and 15-year property (land improvements like parking lots, sidewalks, landscaping). When combined with 100% bonus depreciation (permanently restored by OBBBA), the reclassified components can be fully deducted in Year 1.
What a cost segregation study reclassifies (typical residential rental):
- 5-year property (20-30% of building cost): Carpet and padding, appliances, window treatments, decorative lighting, cabinet hardware, vinyl flooring, specialty electrical (dedicated circuits for appliances).
- 7-year property (5-10% of building cost): Office furniture (if furnished), specialty items.
- 15-year property (5-15% of building cost): Sidewalks, driveways, parking areas, landscaping, fencing, exterior lighting, retaining walls.
- Remaining (50-70%): Stays at 27.5-year residential or 39-year commercial.
Bonus depreciation (OBBBA): 100% bonus depreciation applies to property with a recovery period of 20 years or less. All 5-year, 7-year, and 15-year components can be fully deducted in Year 1. This means 30-55% of the building’s cost can potentially be deducted in the first year.
When to do a cost segregation study: Properties purchased for $500,000+ generally produce enough reclassified value to justify the study cost ($5,000-$15,000). Properties under $500,000 may not generate enough accelerated depreciation to cover the study fee.
How much does cost segregation save?
Who benefits from cost segregation?
Cost segregation is most valuable for:
- Real estate professionals (more than 750 hours a year, and more than half their working time, in real property trades or businesses) who also materially participate in the rental, and can then use rental losses against W-2 and active business income, subject to the excess business loss cap.
- High-income investors who have other passive income to offset (rental losses from one property offsetting rental income from another).
- Investors who plan to do a like-kind exchange (the accelerated depreciation provides tax deferral now, and the 1031 exchange defers the recapture at sale).
Cost segregation is less valuable for investors with modified AGI above $150,000 who do not qualify as real estate professionals, because the passive activity rules prevent the excess losses from offsetting W-2 income. The losses carry forward as suspended passive losses and are released when the property is sold or when the investor has passive income from other sources.
Related guides:
- Real Estate Agent 1099 Reporting Commission Income
- Real Estate Agent Entity Structure Scorp
- Real Estate Agent Estimated Tax Payments
- Real Estate Agent Home Office Deduction
- Real Estate Agent Marketing Deductions
What is the difference between Section 179 and bonus depreciation?
Both allow accelerated cost recovery, but they work differently. Section 179 lets you deduct the full cost of qualifying assets in the year placed in service, up to an annual limit ($1,220,000 in 2024), but only against net business income (it cannot create a loss). Bonus depreciation (60% in 2024, phasing down 20% per year) applies to both new and used property with no dollar limit and can create a net operating loss. Section 179 requires an active election on the return. Bonus depreciation applies automatically unless you elect out. For most small businesses, Section 179 is preferred when income supports the deduction. Bonus depreciation is better when you want to generate or increase a loss for carryforward.
What is bonus depreciation and how has it changed recently?
Bonus depreciation allows you to deduct a large percentage of an asset’s cost in the first year, rather than spreading it over the full MACRS recovery period. Under the Tax Cuts and Jobs Act, bonus depreciation was 100% for assets placed in service from September 27, 2017 through December 31, 2022. It began phasing down by 20% per year: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027. Unlike Section 179, bonus depreciation can create or increase a net operating loss, which you can then carry forward to offset future income. Bonus depreciation applies to new and used property (the TCJA removed the new-only requirement), as long as you have not previously used the asset.
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Yarik Yarosh, CPA. "Cost Segregation for Rental Properties: Accelerating Depreciation to Reduce Taxes." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/real-estate-investing-cost-segregation
This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.