Cost Segregation Study: What the IRS Audit Guide Accepts, 100% Bonus Depreciation After January 19, 2025, and the Math on a $1 Million Rental

What a cost segregation study is, in the IRS's words

The IRS explains the idea in the first pages of its audit guide. A building is section 1250 property: residential rental property recovered over 27.5 years or nonresidential real property recovered over 39 years, which “must use straight-line depreciation.” Equipment, furniture and fixtures are section 1245 property with “a shorter recovery period (e.g., 5 or 7 years)” that can also take bonus depreciation. “Therefore, a faster depreciation write-off (and tax benefit) can be obtained by allocating costs to § 1245 property.” A study is the engineering and cost work that supports that allocation when you only have a lump-sum purchase price.

The legal test for what counts as personal property rather than building comes from the old investment tax credit rules, which the Tax Court applied to depreciation in Hospital Corporation of America, 109 T.C. 21 (1997), as the guide recounts. The guide also flags what it calls “often a contentious issue”: allocating parts of building systems, such as a share of the electrical system feeding equipment, to section 1245 property.

Two caveats about the source itself. First, the guide says of itself: “This ATG is not an official IRS pronouncement and may not be cited as authority.” It is the manual examiners use, which is why it is worth reading before you pay for a study. Second, its current revision is dated February 6, 2025, five months before P.L. 119-21 was signed, so its bonus depreciation table shows the old phase-down. The statute and Notice 2026-11, below, are the current law.

What the IRS says makes a study acceptable

The guide is blunt that there is no official standard: “The Internal Revenue Service (Service) has not established any requirements or standards for the preparation of cost segregation studies.” What it gives instead is a description of a study that “is both accurate and well-documented”, which it calls a quality study, built from these 13 elements (Chapter 4.C):

The guide also names six ways studies are done: detailed engineering from actual cost records, detailed engineering cost estimates, survey or letter, residual estimation, sampling or modeling, and rule of thumb. It calls the first “the most methodical and accurate approach”, and says this of the last, which assigns a fixed percentage from “industry averages” (its example is 40% for a manufacturing facility): “An examiner should view this approach with caution since it lacks sufficient documentation to support its allocation of project costs.” For acquired buildings, where there are no construction invoices, it says “A field inspection is recommended for all quality studies.”

One example in the guide is worth knowing because it is the trick that fails. A warehouse bought for $5 million with land worth $1.88 million left $3.12 million for improvements, but the study's estimates added up to only $2.6 million, so it multiplied every estimate by 1.2, raising section 1245 property from $800,000 to $960,000. The guide's verdict: “Applying a pro-rata step-up factor to the improvements and personal property is not an acceptable method of establishing the depreciable basis of the acquired items.” A gap between estimates and price has to be explained, for example by the land value being wrong.

What goes where: the IRS matrix for rental property

Chapter 7.H of the guide is a classification matrix written for residential rental property, a building where 80% or more of gross rental income comes from dwelling units (26 U.S.C. 168(e)(2)(A)). The guide tells examiners that if the taxpayer's return is consistent with the matrix, “examiners should not make adjustments to categorization and recovery periods.” A sample:

Publication 946 says the same about the 5-year items in a plain list of 5-year property: “Appliances, carpets, furniture, etc., used in a residential rental real estate activity.” Land is the piece nobody depreciates: “You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up” (Publication 946). That makes the land value in the study the first number to check, and it is the one the guide lists first among the reasons estimates go wrong (“Incorrect FMV of the land”).

The statutory recovery periods and methods are in 26 U.S.C. 168(c) and (b): 5-year and 7-year property use the 200% declining balance method, 15-year property 150% declining balance, and residential rental and nonresidential real property straight line over 27.5 and 39 years.

Bonus depreciation in 2025 and 2026: the date that matters is January 19, 2025

This is where most of the money is, and where most summaries online are imprecise.

The rule now. Section 168(k)(1)(A), as amended, allows “an allowance equal to 100 percent of the adjusted basis of the qualified property” in the year it is placed in service. Qualified property means, among other things, property “which has a recovery period of 20 years or less” (section 168(k)(2)(A)(i)(I)). So the 5-, 7- and 15-year pieces a study identifies can qualify; the 27.5- or 39-year building cannot.

Who gets 100%. Section 70301(c)(1) of P.L. 119-21: “the amendments made by this section shall apply to property acquired after January 19, 2025.” IRS Notice 2026-11 describes the result as “a permanent 100 percent additional first year depreciation deduction for qualified property acquired and placed in service” after January 19, 2025, and confirms the law also removed the old requirement to place property in service before January 1, 2027. The acquisition date is tested with a contract rule: property is not treated as acquired after the date a written binding contract is entered into (section 70301(c)(4), as described in Notice 2026-11, which applies the rules of 26 CFR 1.168(k)-2(b)(5) with “January 19, 2025” substituted). Under those rules the acquisition date for a binding contract is the latest of the contract date, the date it becomes enforceable, the end of any cancellation period, and the date contingencies are satisfied.

Who does not. Property acquired on or before January 19, 2025 keeps the phase-down the Tax Cuts and Jobs Act set, which the IRS audit guide tabulates:

The left column is the guide's table for general qualified property and Notice 2026-11's statement that the rate was “40 percent for qualified property placed in service during 2025”; the right column is section 168(k) as amended. For the first taxable year ending after January 19, 2025 (2025, for a calendar-year individual), section 168(k)(10) lets you elect 40% instead of 100%, and section 168(k)(7) lets you elect out of bonus for a whole class of property. A buyer who wants smaller, steadier deductions has those choices.

Used buildings qualify. Bonus applies to used property if you (or a predecessor) had no depreciable interest in it during the prior five calendar years and you did not buy it from a related party (26 CFR 1.168(k)-2(b)(3)(iii)). That covers the usual case of buying an existing rental from a stranger.

One exclusion that catches landlords who borrowed. Publication 946: “If you are required to use ADS to depreciate your property, you cannot claim any special depreciation allowance.” An electing real property trade or business under section 163(j)(7)(B) must use ADS for certain property and cannot claim bonus on it (Rev. Proc. 2026-17, which also lets some taxpayers withdraw that election for the year it was made). Check this with whoever prepares your return before you count on the deduction.

A $1,000,000 rental, worked through

Everything here is illustrative. The price and land value are round inputs, not data; the rates come from IRS Publication 946, Tables A-1 and A-6; the sums are our arithmetic. The IRS guide gives no typical percentage for a rental, and it warns against studies that use one, so we show the result per $100,000 the study supports rather than a made-up split.

The baseline. You buy a residential rental for $1,000,000 and place it in service in January. Land is worth $200,000 (assumed), leaving $800,000 of building. Table A-6 gives 3.485% for the first year of 27.5-year property placed in service in January and 3.636% for a full year after that, so depreciation is $27,880 in year one and $29,088 a year after (our arithmetic).

Per $100,000 a study moves out of the building. Year-one deduction for each $100,000, by class and bonus rate (Table A-1 rates are applied after bonus; half-year convention):

So with 100% bonus, each $100,000 the study supports adds $96,515 to the first-year deduction ($100,000 minus $3,485, our arithmetic). With 20% bonus the gain is $32,515 for 5-year property and $20,515 for 15-year property.

What the first year looks like, depending on what your study supports (100% bonus, our arithmetic: amount reclassified + 3.485% of what stays in the building):

Two timing details from section 168(d) change these numbers. Real property uses the mid-month convention, so a later purchase month gives less in year one (Table A-6 runs from 3.485% for January down to 0.152% for December). And if more than 40% of the aggregate bases of the property you place in service during the year goes in during the last three months, the mid-quarter convention applies to all of it; residential rental and nonresidential real property are left out of that count (section 168(d)(3)). With 100% bonus the whole cost of the short-lived pieces is deducted in the first year either way, so the convention matters for the 20% and no-bonus columns.

The deduction is not the tax saving. What the deduction is worth depends on your rate and, before that, on whether section 469 lets you use it at all.

Whether you can use the loss: section 469

A large first-year deduction usually turns a rental into a tax loss. Section 469(c)(2) says the term passive activity “includes any rental activity”, and passive losses only offset passive income; what is left is carried to the next year (section 469(b)) and released when you dispose of your entire interest (section 469(g)). Publication 925 adds: “A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional.” The ways out:

• The $25,000 allowance. If you actively participate, up to $25,000 of rental loss can offset other income (section 469(i)(2)), reduced by 50% of modified AGI above $100,000 (section 469(i)(3)(A)). Publication 925: at $150,000 or more, “you generally can't use the special allowance.” For many people who buy a $1 million rental, this route is closed.
• Real estate professional status. Under section 469(c)(7)(B), “more than one-half of the personal services” you perform in trades or businesses must be in real property trades or businesses in which you materially participate, and you must perform “more than 750 hours” in them. On a joint return one spouse has to meet both tests alone. You then still need to materially participate in the rental itself; the first of the tests in 26 CFR 1.469-5T(a) is more than 500 hours in the activity.
• Short stays. Under 26 CFR 1.469-1T(e)(3)(ii)(A), an activity is not a rental activity if “the average period of customer use for such property is seven days or less.” It is then judged under the material participation tests like any business: a trade or business is passive only if you do not materially participate (section 469(c)(1)). This is the rule behind the short-term rental strategies in the search results; it does not make the loss non-passive on its own.

A study on a building you already own: Form 3115

You do not need to amend old returns to catch up. Rev. Proc. 2025-23, the current list of automatic accounting method changes, covers changing “from an impermissible to a permissible method of accounting for depreciation” under section 6.01, with designated change number 7, if you used the old method for at least two years (a building placed in service last year has its own rule in section 6.01(1)(b)). The catch-up is a section 481(a) adjustment, and under Rev. Proc. 2015-13 a negative adjustment, the deduction you missed, is taken in one taxable year; a positive one is spread over four. The Form 3115 instructions say the original goes with your timely filed return and a signed copy goes to the IRS National Office.

What change 7 does not cover matters: any section 1250 property that is reclassified into an asset class “that does not explicitly include § 1250 property (for example, asset class 57.0, Distributive Trades and Services)”, and making or revoking a bonus election late (section 6.01(1)(c)(v) and (vi)). A look-back study corrects items that were always personal property but sat in the building account; it cannot turn the building into 5-year property. And bonus for that old property is whatever rate applied when it was acquired and placed in service.

The bill on sale: recapture

Depreciation lowers your basis, so a sale brings it back:

• Section 1245 property (the 5- and 7-year items): on a sale, the lower of the recomputed basis or the amount realized, minus adjusted basis, “shall be treated as ordinary income” (26 U.S.C. 1245(a)(1)). Note the lower-of: a carpet fully deducted in year one and worth little ten years later produces little 1245 recapture, which is why the allocation of the sale price among components matters as much as the original study.
• The building (section 1250 property): section 1250 recaptures as ordinary income only “additional depreciation”, meaning depreciation in excess of straight line (26 U.S.C. 1250(b)(1)). Residential and commercial buildings are straight line, so the building's depreciation is usually “unrecaptured section 1250 gain”, taxed at no more than 25% (26 U.S.C. 1(h)(1)(E) and 1(h)(6)).

How the recapture of a specific property is computed is in our guide to depreciation recapture on rental property. A 1031 exchange can defer the gain if you buy another property within the deadlines; see our 1031 timeline for a late-2026 sale.

If you own real estate through crowdfunding or a fund

You cannot order a study on a REIT share or a crowdfunding deal; the sponsor decides. In a deal that sends a Schedule K-1, a study the sponsor commissions flows through to your share of depreciation and can create a passive loss, subject to the same section 469 rules. The $25,000 allowance is usually out of reach there: an interest of less than 10 percent by value is not active participation (section 469(i)(6)(A)), and neither, except as regulations provide, is an interest as a limited partner (section 469(i)(6)(C)). In a REIT you get the result indirectly, through return of capital in box 3 of the 1099-DIV. Our guide to real estate crowdfunding taxes covers which platforms send which form.

What a reader can do with this

• Pin down the acquisition date first. If your purchase contract was binding on or before January 19, 2025, plan on 40% (2025) or 20% (2026) bonus, not 100%.
• Before paying for a study, ask for the method and a sample report, and check it against the 13 elements above. A quote based on a percentage of the price with no site visit is the rule-of-thumb approach the IRS guide says lacks support.
• Check the land value the study uses against your appraisal or the assessor's split; it is the first item in the guide's list of what goes wrong.
• Run the section 469 test before the deduction test. If your income is over $150,000 and you are not a real estate professional (and not running a short-stay rental you materially participate in), a bigger first-year loss is likely to be suspended, not used.
• Model the sale. The deduction comes back as ordinary income on 1245 property and up to 25% on the building; a sale soon after purchase can give back much of the benefit.
• For a building you already own, the catch-up goes on Form 3115, change number 7, in the year you file it.

FAQ

Sources, read and saved on October 7, 2026: IRS Publication 5653, Cost Segregation Audit Techniques Guide (revised February 6, 2025); IRS Notice 2026-11; Public Law 119-21, section 70301 (July 4, 2025); 26 U.S.C. 1(h), 168, 469, 1245 and 1250 on Cornell's Legal Information Institute; 26 CFR 1.168(k)-2, 1.469-1T and 1.469-5T on the eCFR; Rev. Proc. 2025-23, Rev. Proc. 2015-13 and Rev. Proc. 2026-17; IRS Instructions for Form 3115 (Rev. December 2022); IRS Publication 946 (2025) and Publication 925 (2025). The $1,000,000 example, its land value and every sum, multiple and difference are our arithmetic on illustrative inputs. This is analysis of public documents and the law, not tax, legal or investment advice.