Cost Segregation Studies for Rental Properties: What Every Investor Needs to Know

What is a cost segregation study?

A cost segregation study is an engineering-based tax analysis that breaks a real estate investment into its individual components, and assigns each component the depreciation schedule it actually qualifies for under IRS rules.

When you buy a rental property, the IRS treats the entire building as a single asset and requires you to depreciate it over 27.5 years for residential real estate (or 39 years for commercial), according to IRS Publication 527. That seems straightforward until you realize that not everything in a building is a wall or a roof. Carpet, cabinetry, appliances, parking lots, specialty electrical systems, and landscaping all have shorter useful lives, and the tax code allows them to be depreciated over 5, 7, or 15 years instead.

A cost segregation study identifies and formally reclassifies those shorter-lived components. The result is front-loaded depreciation deductions that help get you tax savings when your tax bill is highest.

100% bonus depreciation is back, baby

To understand why cost segregation has become so powerful right now, you need to understand bonus depreciation.

Under the original Tax Cuts and Jobs Act of 2017 (TCJA), investors could immediately deduct 100% of the cost of qualifying short-lived assets in the year they were placed in service. This was transformative. But the TCJA included a phasedown schedule: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and then gone.

Then came the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025. It permanently restored 100% bonus depreciation for qualified property placed in service after January 19, 2025, extending through December 31, 2029.

What this means for cost segregation is significant: when a study identifies that 20–40% of your building's purchase price consists of 5-, 7-, or 15-year property, all of that can potentially be deducted in full in year one. That's not a typo.

But there's a catch! Property must be both acquired and placed in service after January 19, 2025 to qualify for the full 100% rate. If you had a written binding contract to purchase the property before that date, even if you didn't close until after, you may still be limited to the prior 40% rate. Documentation of your acquisition date matters enormously here.

Check out this real-world example

Say you purchase a residential rental property for $800,000 in March 2025, with $650,000 allocated to the building structure (land is never depreciable).

Without a cost segregation study:

• Annual depreciation: $650,000 ÷ 27.5 years = approximately $23,636
• Year-one federal tax savings at a 32% bracket: roughly $7,564

With a cost segregation study (assuming 25% of building value, or $162,500, is reclassified as 5- or 15-year property eligible for 100% bonus depreciation):

• Immediate bonus depreciation deduction: $162,500
• Remaining building depreciation (on $487,500): approximately $17,727
• Total year-one depreciation: $180,227
• Year-one federal tax savings at a 32% bracket: approximately $57,673

That's a difference of roughly $50,000 in real tax savings in a single year. The cost of the study itself? Typically $5,000–$15,000 depending on property size and complexity, which makes this endeavor a clear return on investment.

Beware what gets reclassified, and what doesn't

Not everything inside a building qualifies for accelerated depreciation. Here's how to think about it:

• Typically reclassified as 5- or 7-year property (personal property): Appliances, carpeting, specialty lighting fixtures, decorative millwork, window treatments, certain plumbing fixtures, and furniture in furnished rentals.‍
• Typically reclassified as 15-year property (land improvements): Parking lots, sidewalks, fencing, landscaping, outdoor lighting, driveways, and retaining walls.‍
• What stays at 27.5 years (the building itself): Load-bearing walls, the roof structure, foundation, HVAC tied to the building structure, windows, and doors. These are considered structural components under IRS rules and cannot be accelerated simply through a cost segregation study.

Keeper pro tip: residential properties tend to yield reclassification of 20–30% of total building value; commercial properties can run 25–45%. The higher the property value and the more interior finishes involved, the more a study can uncover.

How passive activity rules can derail things

The IRS treats rental activity as passive income for most people. That means losses generated by rental properties (including large depreciation deductions) can ordinarily only offset other passive income — not your W-2 wages or business income.

So if you're a high-income earner who just unlocked $150,000 in year-one depreciation through a cost segregation study, you may not be able to use all of it immediately unless one of the following applies:

1. ‍The $25,000 Rental Loss Allowance: If your modified adjusted gross income (MAGI) is under $100,000 and you actively participate in managing the rental, you can deduct up to $25,000 in rental losses against ordinary income. This phases out between $100,000 and $150,000 MAGI.‍
2. Real Estate Professional Status (REPS): If more than half of your working hours and at least 750 hours per year are spent in real property trades or businesses in which you materially participate, the IRS removes the passive classification entirely. Your rental losses, including bonus depreciation, can offset any income. This is documented on your tax return and is frequently audited, so records are essential.‍
3. The Short-Term Rental (STR) Loophole: If the average rental period for your property is seven days or less and you materially participate in managing it, the IRS does not treat it as passive income.

What if I bought my property years ago?

One of the most underutilized aspects of cost segregation is the ability to apply it to properties you already own, even years after purchase, without needing to amend prior year tax returns.

You can do this with Form 3115 (Application for Change in Accounting Method). The IRS allows a "catch-up" adjustment that lets you claim all the missed accelerated depreciation in a single year. If you bought a duplex in 2019 and never did a cost segregation study, you may be able to take a substantial deduction this filing season to account for years of missed depreciation.

This makes cost segregation worth evaluating for:

• Properties purchased in the past 10–15 years that have never had a study
• Properties that underwent significant renovations
• Commercial buildings with a high proportion of interior finishes

The study cost for a look-back is similar to a new-purchase study. A qualified CPA or cost segregation specialist can give you a preliminary estimate of potential deductions before you commit to the full analysis. Book a call with a Keeper tax pro if you need help.

When does a cost segregation study make sense?

Cost segregation is not the right strategy for everyone, so you can start by asking yourself if any of the following applies to you:

Strong candidates:

• Rental property valued at $500,000 or more
• High-income taxpayers who qualify for REPS, the STR loophole, or have substantial passive income to offset
• Long-term hold strategies (10+ years) where recapture can be deferred or avoided
• Investors who recently completed significant capital improvements

Weaker candidates:

• Low-income earners who are already at or below their effective tax rate
• Investors planning to sell within 2–3 years without a 1031 exchange plan
• Properties below $300,000 in value, where study costs may eat into net benefits
• Primary residences (ineligible entirely)

Keeper pro tip: The study fee, typically $5,000–$15,000 for residential properties, is a deductible business expense in the year it's incurred!

Cost segregation study checklist for next steps

If you're considering a cost segregation study, here's how a well-organized process looks:

1. Talk to your CPA first. Before engaging any cost segregation firm, your CPA should assess whether you can actually use the deductions. Passive loss limitations are the most common reason a study that looks great on paper delivers limited near-term benefit.
2. Get a preliminary estimate. Most reputable firms (like KBKG, a firm recognized by the American Society of Cost Segregation Professionals) offer a no-cost preliminary analysis to estimate potential reclassification before you commission a full study.
3. Verify the firm's credentials. The IRS has published audit technique guidelines for cost segregation that set standards for study quality. Look for firms staffed by engineers and CPAs, and ask whether their studies have withstood IRS examination.
4. Confirm your property's acquisition date. For properties acquired after January 19, 2025, confirm you have documentation establishing both the acquisition date and placed-in-service date to qualify for the 100% bonus depreciation rate. IRS Notice 2026-11 and Notice 2026-16 provide additional interim guidance on transition-year rules.
5. Plan for recapture. Before year-end, discuss with your CPA how you'll eventually exit the property and whether a 1031 exchange strategy (which allows you to defer paying capital gains tax on the sale of a property by reinvesting the proceeds into other real estate) is part of the long-term plan.