The recent restoration of 100% bonus depreciation under the One Big Beautiful Bill Act (OBBBA) has greatly enhanced the value of cost segregation – a tax strategy that allows real estate owners and investors to accelerate depreciation deductions by reclassifying building components into shorter-lived asset classes. 

BACKGROUND AND MECHANICS OF COST SEGREGATION

A cost segregation study is an engineering-based analysis that identifies and allocates the costs of building components into asset classes with shorter depreciable lives, typically five, seven or 15 years, rather than the standard 27.5-year (residential) or 39-year (commercial) periods. 

The process involves a detailed review of construction documents, blueprints and site inspections to properly classify assets. Common classifications include:

• Personal Property (five or seven years): Items such as specialty wiring, carpeting, decorative lighting and signage
• Land Improvements (15 years): Parking lots, landscaping, fencing and similar exterior features
• Building Systems (27.5 or 39 years): Structural framework, exterior walls, general HVAC and plumbing

The primary benefit of cost segregation is the ability to shift a significant portion of a building’s cost into categories eligible for accelerated depreciation, especially when combined with bonus depreciation provisions. 

To withstand IRS scrutiny, these studies must be well-documented and typically follow IRS-recognized engineering methodologies and safe-harbor guidance.

PRE-OBBBA TAX ENVIRONMENT

Before the passage of the OBBBA, bonus depreciation under IRC §168(k) was scheduled to phase down as follows:

• 60% for property placed in service in 2024
• 40% in 2025
• 20% in 2026
• Full phaseout for years after 2026 

Despite limitations, cost segregation remained a valuable tool for maximizing available deductions.

OBBBA UPDATE: PERMANENT 100% BONUS DEPRECIATION

The OBBBA, passed on July 4, 2025, permanently restores 100% bonus depreciation for most Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less for property acquired and placed in service after Jan. 19, 2025. 

This legislative change dramatically increases the value of cost segregation studies, as it allows for the full expensing of qualifying property in the year it is placed in service.

Key Implications:

• Full Expensing: Cost segregation studies that allocate building costs into bonus-eligible classes (e.g., personal property, land improvements) can enable full expensing of those components in year one, resulting in substantial tax savings immediately
• Timing: Property acquired after Jan. 19, 2025 qualifies for the restored 100% bonus depreciation. Property placed in service (or entered into a binding contract to purchase) prior to Jan. 19, 2025 is subject to bonus depreciation of 40% under the pre-OBBBA tax rules. The OBBBA allows taxpayers to elect 40% bonus depreciation for the first tax year ending after Jan. 19, 2025
• Qualified Production Property (QPP): The OBBBA introduces a new class allowing immediate expensing of the production-use portion of nonresidential real property used in manufacturing, further expanding cost segregation opportunities for industrial facilities

Considerations and Caveats:

• Eligibility: Not all property qualifies for accelerated depreciation. Building shells, structural components and certain used property may be excluded. Acquisition date and whether the property is new or used are also relevant
• State Tax Conformity: Many states do not conform to federal bonus depreciation rules, so state tax benefits may differ
• Recapture Risk: Accelerated deductions may trigger §1245 or §1250 recapture upon sale or change in use, requiring careful planning
• Other Limitations: Tax-basis, at-risk and passive activity rules still apply
• Cost-Benefit Analysis: The cost of a study should be weighed against the expected tax savings
• §163(j) Election: If the entity has already elected out of §163(j) through the Electing Real Property Trade or Business election, benefits from a cost segregation may be limited. Under §168(h)(8), Qualified Improvement Property held by Electing Real Property Trade or Businesses are required to be depreciated under the Alterative Depreciation System, disallowing those assets from accelerated depreciation under section §168(k)

Impact of 100% Bonus Depreciation:

To illustrate the benefits of accelerated depreciation, the table below compares federal income tax savings from depreciation on a property with and without a cost segregation study. 

For example, assume the taxpayer’s effective tax rate is 29.6% (37% marginal rate less the tax benefit for the qualified business income deduction), and a nonresidential property was purchased and placed in service on July 1, 2025. The allocable purchase price to the building was $5 million and a cost segregation study identified $2 million of building components that are asset classes eligible for bonus depreciation. In the first year, depreciation on the building would follow the mid-month convention, with depreciation expense of 5.5/12 of the annual depreciation for the first year. 

Annual Depreciation:

First Year Depreciation:

The cost segregation study allows for the acceleration of tax deductions of $1,976,495 in Year 1, and cumulatively $1,771,367 over the first five years. At the effective tax rate of 29.6%, these accelerated deductions reduce Year 1 tax liability by $585,043 and cumulatively reduce tax liability over the first five years by $524,323. 

This acceleration improves near-term cash flow and internal rates of return by substantially reducing taxable income in Year 1. 

BEST PRACTICES FOR BUSINESS OWNERS

Engage a cost segregation specialist at the acquisition of the property or during major renovations to maximize the benefit and ensure proper timing. It is important to also consider the benefits of a cost segregation of a property already owned. Analyze the cost to prepare and file Form 3115 to properly change the accounting method for depreciating the property with the tax benefit of the accelerated deduction. Ensure assets are placed in service after Jan. 19, 2025 to qualify for 100% bonus depreciation.

Further, prepare projections showing the year-one deduction, future-year depreciation and cash-flow impact to demonstrate the return on investment of a cost segregation study. Throughout all of this, maintain detailed engineering reports, asset schedules and internal memos to support reclassifications and comply with IRS standards. Business owners should also be sure to analyze state conformity to federal bonus depreciation and adjust planning accordingly.

Lastly, consider the interaction of a cost segregation study with §163(j) (interest deduction limits), §199A (QBI deduction), real estate professional status and passive activity rules.

REAL ESTATE TAX STRATEGIES AND NEXT STEPS

Cost segregation is a powerful tax planning tool, and the restoration of 100% bonus depreciation under the OBBBA has made it even more valuable. Real estate owners and investors should act now to evaluate their properties, model potential tax outcomes and perform cost segregation studies where appropriate. 

Get in touch with GHJ’s Real Estate Practice to learn more about how these changes may impact your specific situation and to determine whether a cost segregation study is appropriate for your current or planned real estate ventures.