Frequently Asked Questions
Browse answers about cost segregation, real estate tax strategies, and depreciation.
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Yes. Bonus depreciation is treated as depreciation for all tax purposes, including recapture.
When you sell a property at a gain, the IRS requires you to "recapture" previously claimed depreciation. This means a portion of your gain is taxed at higher rates than standard capital gains rates.
How recapture works:
Depreciation reduces your adjusted basis in the property. When you sell, gain is calculated as the difference between the sales price and your adjusted basis. The lower your basis, the higher your gain.
The IRS divides this gain into categories based on property type and the type of depreciation claimed.
Recapture rules by property type:
Section 1245 property (personal property):
This includes 5-year and 7-year property identified in cost segregation studies: appliances, carpeting, fixtures, furniture, and equipment.
All depreciation claimed on Section 1245 property, including bonus depreciation, is recaptured as ordinary income at your marginal tax rate (up to 37%).
Section 1250 property (real property improvements):
This includes 15-year land improvements, qualified improvement property, and building structures.
Section 1250 recapture has two components that investors should understand:
Component 1: Additional depreciation (ordinary income recapture)
For Section 1250 property, the IRS treats bonus depreciation as an accelerated depreciation method. The difference between the bonus depreciation claimed and the straight-line depreciation that would have been claimed is considered "additional depreciation."
Under IRC § 1250(a), this additional depreciation may be recaptured as ordinary income (up to 37%) rather than at the 25% rate.
Example: An investor claims $100,000 in bonus depreciation on 15-year land improvements in Year 1. Straight-line depreciation would have been $6,667 in Year 1. The "additional depreciation" is $93,333 ($100,000 - $6,667). If the property is sold at a gain, this $93,333 may be subject to ordinary income recapture.
Component 2: Unrecaptured Section 1250 gain (25% rate)
After accounting for any ordinary income recapture, remaining depreciation on Section 1250 property is taxed at a maximum rate of 25%. This is commonly called "unrecaptured Section 1250 gain."
Practical impact:
The distinction between these two components affects the tax rate on depreciation recapture:
Planning note: Despite the potential for ordinary income recapture on the "additional depreciation" component, the time value of money and deferral strategies (especially 1031 exchanges) typically still favor claiming bonus depreciation. Consult your CPA to model the specific impact for your situation.
Does recapture eliminate the benefit of bonus depreciation?
No. Bonus depreciation remains beneficial for three reasons.
Reason 1: Time value of money.
A dollar saved today is worth more than a dollar paid in taxes years later. If you claim $100,000 in bonus depreciation today and pay recapture in 10 years, you have had use of that money for a decade. Invested wisely, those funds generate additional returns.
Example: An investor saves $37,000 in taxes through bonus depreciation (at 37% rate). They invest the savings at 7% annual return. After 10 years, the investment grows to approximately $72,750. Even after paying recapture tax, they retain significantly more than if they had never claimed bonus depreciation.
Reason 2: Rate differential.
Bonus depreciation offsets income at your current marginal rate, which may be as high as 37%. Unrecaptured Section 1250 gain is capped at 25%. This spread creates permanent tax savings for the portion taxed at the lower recapture rate.
Reason 3: Deferral strategies exist.
Investors can defer recapture indefinitely through a 1031 exchange. By exchanging into like-kind replacement property, both capital gains and depreciation recapture are deferred. Many investors continue exchanging throughout their lifetime, and heirs receive a stepped-up basis at death, potentially eliminating recapture entirely.
Planning strategies to manage recapture
Strategy 1: 1031 exchange.
A properly structured 1031 exchange defers all gain, including depreciation recapture. The deferred depreciation carries over to the replacement property, reducing its basis. Recapture is only triggered when you eventually sell without exchanging.
Many investors use serial 1031 exchanges, continuously deferring gain and recapture while building wealth through larger properties.
Strategy 2: Installment sale.
Selling property through an installment sale spreads gain recognition over multiple years. Recapture is recognized proportionally as payments are received. This can keep you in lower tax brackets and reduce overall tax liability.
Note: Depreciation recapture on Section 1245 property must be recognized in the year of sale, regardless of installment treatment. Only Section 1250 recapture and capital gain can be spread.
Strategy 3: Opportunity Zone investment.
Reinvesting capital gains into a Qualified Opportunity Zone Fund defers gain recognition. While this does not eliminate recapture, it provides deferral and potential reduction of the gain if the investment is held long enough.
Strategy 4: Charitable giving.
Donating appreciated property to a qualified charity may allow you to avoid both capital gains and recapture. You receive a charitable deduction for the fair market value of the property. Consult with your tax advisor on specific requirements and limitations.
Strategy 5: Hold until death.
Under current law, heirs receive a stepped-up basis in inherited property. This eliminates all built-in gain, including depreciation recapture. Holding property until death can be the most tax-efficient exit strategy for some investors.
Recapture and cost segregation: The full picture
Some investors hesitate to pursue cost segregation because of recapture concerns. This hesitation is often misplaced.
Consider the math:
An investor has two options:
Option A: No cost segregation.
- Annual depreciation: $36,364 (straight-line over 27.5 years)
- Year 1 tax savings (at 37%): $13,455
Option B: Cost segregation with bonus depreciation.
- Year 1 depreciation: $277,273 (including $250,000 bonus)
- Year 1 tax savings (at 37%): $102,591
Difference in Year 1 tax savings: $89,136
Even accounting for higher recapture upon sale, Option B generates significantly more present-value benefit. The investor has $89,136 more cash in Year 1 to reinvest, pay down debt, or acquire additional properties.
The bottom line:
Recapture is a factor to consider, not a reason to avoid bonus depreciation. The tax savings today, rate differential, and available deferral strategies typically make bonus depreciation the superior choice.
Work with your CPA to model the full tax impact, including projected holding period and exit strategy. Understanding recapture upfront allows you to plan accordingly and maximize after-tax wealth.
Bonus depreciation and Section 179 are both first-year depreciation incentives, but they operate under different rules. Understanding these differences helps investors choose the right strategy.
Key differences:
Dollar limits:
Bonus depreciation has no annual dollar limit. You can claim 100% of qualifying property costs regardless of the total amount.
Section 179 has an annual deduction limit of $1,250,000 for 2025. This limit begins phasing out dollar-for-dollar when total qualifying property placed in service exceeds $3,130,000. At $4,380,000 in qualifying property, the Section 179 deduction phases out completely.
Loss limitations:
This is one of the most significant differences. Bonus depreciation can create or increase a net operating loss. Section 179 cannot.
Section 179 deductions are limited to taxable income from all active trades or businesses. If your business income is $100,000, your Section 179 deduction cannot exceed $100,000 (even if you have $500,000 in qualifying property). Unused Section 179 amounts carry forward to future years.
Bonus depreciation has no such limitation. It can reduce taxable income below zero, creating a loss that carries forward under NOL rules.
Election requirements:
Bonus depreciation applies automatically to all qualifying property unless you elect out. No affirmative election is needed to claim it.
Section 179 requires an affirmative election. You must specifically identify the property and the amount you are expensing on Form 4562.
Eligible taxpayers:
Bonus depreciation is available to all taxpayers, including individuals, corporations, partnerships, S corporations, trusts, and estates.
Section 179 is not available to estates and trusts. This limitation makes bonus depreciation particularly valuable for trust-owned real estate.
Order of application:
When both provisions apply to the same property, Section 179 is applied first. Bonus depreciation then applies to the remaining basis.
Example: You purchase $200,000 of qualifying equipment. You elect $100,000 of Section 179. The remaining $100,000 basis is eligible for bonus depreciation. At 100% bonus, you deduct the remaining $100,000. Total first-year deduction: $200,000.
Yes. Rental property owners can claim bonus depreciation on qualifying components of their investment.
The building structure itself does not qualify. Residential rental buildings depreciate over 27.5 years. Commercial buildings depreciate over 39 years. Neither recovery period meets the 20-year-or-less requirement for bonus depreciation.
However, buildings contain many components that do qualify. These include personal property (appliances, carpeting, fixtures) and land improvements (parking lots, landscaping, fencing). A cost segregation study identifies these components and reclassifies them into shorter recovery periods.
Typical reclassification results:
Once reclassified, these assets qualify for bonus depreciation. For property acquired after January 19, 2025, that means 100% of the reclassified costs can be deducted in Year 1.
Example: An investor purchases a $1.5 million rental property. A cost segregation study reclassifies $300,000 into 5-year and 15-year property. With 100% bonus depreciation, the investor claims a $300,000 deduction in the first year.
At a combined federal and state tax rate of 40%, the immediate tax savings equals $120,000.
Eligibility depends on asset classification and timing. Here is a summary:
Key point: Eligibility is determined at the asset level, not the property level. A single real estate investment may contain dozens of individual assets, each with its own classification.
R.E. Cost Seg specializes in identifying these assets through engineering-based cost segregation studies. The process ensures every qualifying component is properly classified and documented to support bonus depreciation claims.
100% bonus depreciation allows you to deduct the entire cost of qualifying property in the first year it is placed in service. Nothing is left to depreciate in future years.
Under the Big Beautiful Bill (One Big Beautiful Bill Act), 100% bonus depreciation has been restored and made permanent for qualified property acquired after January 19, 2025. The prior phase-down schedule has been eliminated.
Current bonus depreciation rates:
For investors who delayed acquisitions during the phase-down period, the timing is now favorable. Property acquired after January 19, 2025 qualifies for full 100% bonus depreciation with no expiration date.
Note on long production period property and aircraft:
Certain property types have extended bonus depreciation deadlines under the original TCJA phase-down schedule:
- Long production period property (LPP): Property with a production period exceeding one year and costing more than $1 million
- Noncommercial aircraft (NCA): Certain aircraft not used in commercial operations
For property acquired before January 20, 2025, these asset types receive an extra year of favorable treatment:
For LPP and NCA acquired after January 19, 2025, the standard 100% rate applies under the Big Beautiful Bill.
Most real estate investors are not affected by these rules, as LPP and NCA provisions primarily apply to manufacturing equipment and aviation assets. However, investors in specialized facilities (manufacturing plants, aviation hangars) should consult their CPA.
Important: The binding contract rule
The acquisition date for bonus depreciation purposes is determined by when a written binding contract is entered into, not when the property closes or is placed in service.
This distinction matters. Property subject to a binding written contract entered into before January 20, 2025, does not qualify for the 100% rate, even if the property closes and is placed in service after that date. Instead, the phase-down rates apply based on the placed-in-service year.
Example: An investor signs a purchase agreement on January 15, 2025, and closes on March 1, 2025. Despite closing after the January 19, 2025 cutoff, the property is subject to the 40% bonus rate (2025 phase-down) because the binding contract predates the new law.
Example: An investor signs a purchase agreement on February 1, 2025, and closes on April 15, 2025. The property qualifies for 100% bonus depreciation because the binding contract was entered into after January 19, 2025.
What constitutes a binding contract?
A contract is binding if it is enforceable under state law and does not limit damages to a specified amount (such as forfeiting a deposit). Letters of intent and contracts with significant contingencies may not qualify as binding contracts.
Investors with properties under contract near the January 19, 2025 cutoff should consult their tax advisor to determine which bonus rate applies.
Transitional election: Choosing lower bonus rates
The Big Beautiful Bill includes a transitional rule allowing taxpayers to elect to use the lower phase-down rates instead of 100% bonus depreciation.
For qualified property placed in service in a taxpayer's first tax year ending after January 19, 2025, the taxpayer may elect to use the bonus depreciation rates that were in effect on January 19, 2025 (40% for 2025, 20% for 2026, etc.).
Why elect lower rates?
- Passive activity management: Spreading deductions over time may better match passive income availability
- State tax simplification: Lower federal bonus reduces state add-back amounts in decoupling states
- Income timing: Investors expecting higher tax rates in future years may prefer to defer deductions
- Loss limitation concerns: Avoiding large current-year losses that cannot be used
This election is made on a timely filed return. Consult your CPA to determine whether the transitional election benefits your specific situation.
Yes. Trusts and estates are fully eligible to claim bonus depreciation on qualifying property.
This is an important distinction from Section 179 expensing. Trusts and estates cannot claim Section 179 deductions under IRC § 179(d)(4). However, no such limitation exists for bonus depreciation.
Why this matters:
Many real estate investors hold property in trusts for estate planning, asset protection, or privacy purposes. Common structures include:
- Revocable living trusts
- Irrevocable trusts
- Qualified Personal Residence Trusts (QPRTs)
- Dynasty trusts
- Land trusts
Property held in these structures remains eligible for cost segregation and bonus depreciation. The trust claims the deduction, and it flows through to beneficiaries or remains at the trust level depending on the trust's distributable net income (DNI).
Trust taxation basics:
Trusts and estates are separate taxpayers with their own tax brackets. However, trust tax brackets are highly compressed compared to individual brackets. Trusts reach the top 37% federal tax bracket at a much lower income threshold than individuals.
For 2024, trusts reached the 37% bracket at $14,450 of taxable income. The 2025 threshold is adjusted annually for inflation. Check current IRS guidance for the applicable year.
This compressed rate structure makes bonus depreciation particularly valuable for trusts. Large depreciation deductions can eliminate trust-level taxable income entirely, avoiding the top bracket.
Grantor trusts:
If a trust is a "grantor trust" for tax purposes, all income and deductions are reported on the grantor's individual return. The trust is disregarded for income tax purposes.
In this case, bonus depreciation flows directly to the grantor. The grantor claims the deduction on their Form 1040 as if they owned the property individually.
Non-grantor trusts:
For non-grantor trusts, the trust is a separate taxpayer. Bonus depreciation is claimed on Form 1041 (U.S. Income Tax Return for Estates and Trusts).
If the trust distributes income to beneficiaries, depreciation deductions may be allocated between the trust and beneficiaries based on the trust's accounting income. Consult with a tax professional on specific allocation rules.
Example:
A family irrevocable trust owns a $2 million apartment building. The trust completes a cost segregation study identifying $450,000 in 5-year and 15-year property.
With 100% bonus depreciation, the trust claims a $450,000 first-year deduction. This deduction offsets rental income and may create a loss that passes through to beneficiaries (subject to passive activity rules at the beneficiary level).
Without bonus depreciation availability, the trust would be limited to straight-line depreciation of approximately $54,545 per year ($1.5 million building basis ÷ 27.5 years).
Estate planning benefits:
Bonus depreciation enhances several estate planning strategies:
Installment sales to grantor trusts: A grantor sells appreciated property to an intentionally defective grantor trust (IDGT) in exchange for an installment note. The trust claims bonus depreciation, generating deductions that offset installment payments. This can result in significant wealth transfer with minimal gift tax exposure.
Charitable remainder trusts (CRTs): While CRTs are tax-exempt, the remainder beneficiaries (often family members) eventually receive trust assets. Maximizing depreciation during the trust term preserves asset value.
Qualified Subchapter S Trusts (QSSTs) and Electing Small Business Trusts (ESBTs): These trusts can hold S corporation stock. If the S corporation owns real estate, bonus depreciation passes through to the trust.
Key planning considerations:
Passive activity rules still apply. Trusts are subject to passive activity limitations. Rental losses are generally passive and can only offset passive income at the trust or beneficiary level.
Material participation is difficult. Trusts cannot materially participate in activities in the same manner as individuals. This limits the ability to claim non-passive treatment for rental activities.
Real Estate Professional Status is unavailable. Only individuals can qualify as Real Estate Professionals. Trusts cannot achieve REPS designation.
At-risk rules apply. Trusts are subject to at-risk limitations, restricting losses to amounts the trust has at risk in the activity.
The bottom line:
Trusts and estates benefit significantly from bonus depreciation. Unlike Section 179, no statutory limitation prevents trusts from claiming this valuable deduction.
If you hold real estate in a trust structure, cost segregation and bonus depreciation remain available. Work with your estate planning attorney and CPA to coordinate depreciation strategy with overall trust objectives.
Yes. Taxpayers may elect to forgo bonus depreciation for any class of property placed in service during the tax year.
This election is made on a class-by-class basis. You cannot selectively elect out for individual assets within a class. If you elect out for 5-year property, the election applies to all 5-year property placed in service that year.
How to make the election:
Attach a statement to your timely filed federal tax return (including extensions) for the year the property is placed in service. The statement must specify:
- The class of property for which you are electing out (e.g., "all 5-year property" or "all 15-year property")
- The tax year to which the election applies
No specific form is required. A clear written statement attached to Form 4562 is sufficient.
Revoking the election:
Once made, the election to forgo bonus depreciation can only be revoked with IRS consent. This generally requires a private letter ruling, which involves fees and processing time.
However, Treasury Regulations provide automatic relief in certain situations. Under Treas. Reg. § 301.9100-2(b), taxpayers may revoke the election within six months of the original due date (excluding extensions) by filing an amended return with "Filed pursuant to section 301.9100-2" written at the top.
Reasons to elect out:
Reason 1: Preserve deductions for higher-rate years.
If you expect to be in a significantly higher tax bracket in future years, spreading depreciation may produce greater tax savings. Deductions at a 37% rate are worth more than deductions at a 24% rate.
Example: A medical resident earns $60,000 in 2025 but expects to earn $400,000 by 2028. Electing out of bonus depreciation preserves deductions for higher-income years when the tax benefit is greater.
Reason 2: Manage passive activity limitations.
Passive investors can only use rental losses against passive income. Large bonus depreciation deductions may create suspended losses that carry forward indefinitely.
If you have limited passive income to absorb losses, electing out spreads deductions over time. This matches deductions to income more evenly, reducing suspended loss balances.
Reason 3: State tax simplification.
In states that decouple from federal bonus depreciation, electing out eliminates the need for separate depreciation schedules. Federal and state depreciation match, simplifying compliance and recordkeeping.
Reason 4: Avoid excess recapture.
If you plan to sell the property in the near term, large bonus depreciation increases recapture exposure. Electing out reduces first-year depreciation and preserves basis, potentially lowering gain on sale.
Reason 5: Tax loss harvesting strategy.
Some investors prefer to time losses strategically. Electing out in certain years and claiming bonus depreciation in others allows precise tax planning across multiple properties and tax years.
Reasons NOT to elect out:
Time value of money: A dollar saved today is worth more than a dollar saved tomorrow. Accelerating deductions puts cash in your pocket sooner.
Rate differential: Bonus depreciation offsets income at ordinary rates (up to 37%). Recapture on real property is capped at 25%. This spread creates permanent tax savings.
Reinvestment opportunity: Tax savings can be reinvested in additional properties, accelerating wealth building.
1031 exchange planning: If you plan to exchange rather than sell, recapture is deferred indefinitely. The downside of accelerated depreciation is eliminated.
Election mechanics by entity type:
Individuals and sole proprietors: Attach the election statement to Form 1040 and Form 4562.
Partnerships and S corporations: The election is made at the entity level, not by individual partners or shareholders. Attach the statement to the partnership or S corporation return (Form 1065 or 1120-S).
C corporations: Attach the statement to Form 1120.
Trusts and estates: Attach the statement to Form 1041 and Form 4562.