The property and study
Property: a $600,000 residential rental purchased in 2025. Assume $50,000 is land, so the depreciable building basis is $550,000. Under standard straight-line 27.5-year depreciation, annual deduction = $550,000 ÷ 27.5 = $20,000/year.
A cost segregation study identifies $110,000 of components qualifying as 5-year property (specialty flooring, appliances, cabinets) and $55,000 as 15-year land improvements (landscaping, parking lot, fencing). The remaining $385,000 stays as 27.5-year building.
First-year deduction
With a 40% bonus depreciation rate (2025 example), the 5-year and 15-year components each receive a 40% bonus in year one, with the remaining 60% continuing on their MACRS schedules. Year-one calculation:
• 5-year components: $110,000 × 40% bonus = $44,000 bonus + regular MACRS on remaining $66,000 (year 1 ≈ $13,200) = $57,200
• 15-year land improvements: $55,000 × 40% bonus = $22,000 + regular MACRS on remaining $33,000 (year 1 ≈ $3,300) = $25,300
• 27.5-year building: $385,000 ÷ 27.5 = $14,000 (pro-rated for mid-month)
Total year-one deduction: ≈ $96,500 vs. $20,000 under straight-line. At a 32% tax rate, the extra $76,500 deduction saves roughly $24,500 in year-one taxes.
Recapture at sale (10 years later)
Assume the property sells for $750,000 after 10 years of ownership. By then, total depreciation claimed is roughly $300,000 (the cost-segregated schedule front-loaded the deductions, so the bulk was claimed early). Adjusted basis ≈ $600,000 − $300,000 = $300,000. Total gain = $750,000 − $300,000 = $450,000.
Of the $300,000 of depreciation, some was on Section 1245 property (5-year components, taxed at ordinary rates) and the rest on Section 1250 (capped at 25%). Modeling this precisely requires breaking out each category — use the depreciation recapture calculator to estimate your specific split.
Frequently asked questions
How much can cost segregation save in year one on a $600,000 rental?
On this example, roughly $24,500 in the first year at a 32% marginal rate and 40% bonus rate, compared to $6,400 under straight-line. Actual savings depend on your tax rate, bonus rate, and reclassification results.
What percentage of a residential rental gets reclassified?
In this example, $165,000 of $550,000 (30%) was reclassified. Studies on residential rentals typically reclassify 15–30%.
Does cost segregation change my recapture at sale?
Yes — it increases total depreciation claimed, which increases recapture exposure. But it also lets you defer or invest that tax savings for years before sale.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.