Real Estate Tax Calc
Two recovery periods, one building
A building that combines residential apartments with ground-floor retail or office space has two depreciation schedules: the residential portion depreciates over 27.5 years and the commercial portion over 39 years. When you commission a cost segregation study on a mixed-use property, the engineer must allocate identified personal property and land-improvement components between the two uses.
The simplest and most defensible allocation method is square footage. If 70% of rentable area is residential and 30% is commercial, general building-wide components (parking lot, shared lobby improvements) are allocated 70/30. Components that exclusively serve one use (restaurant kitchen equipment = commercial; apartment fixtures = residential) are fully allocated to that use.
Impact on depreciation and bonus
Components allocated to the residential portion are residential 5-year or 15-year property; those allocated to the commercial portion are commercial 5-year or 15-year property. Fortunately, both categories qualify for bonus depreciation (for property placed in service before the phase-out ends), so the timing impact is the same. The separation matters most for recapture at sale, where you must be able to show which components belong to which use to correctly compute the gain on each portion.
Buildings that are predominantly residential (80% or more residential by gross rent) are treated as entirely residential for MACRS purposes under the de minimis rule in some analyses, but a true mixed-use building must be allocated.
Practical tips
Commission the cost segregation study before or at the time of the first tax return for the property — retroactive studies via Form 3115 are available but more complex. Ask the engineer to provide a schedule that separates residential and commercial components, especially for shared systems like parking and structural improvements. Keep the engineer's report and the allocation workpapers with your tax records permanently, since mixed-use allocations often become important at sale.
The threshold question: the 80% gross-rental-income test
Before you split anything, determine how the building shell is classified, because the tax law does not always let you use two recovery periods for a single building. Under IRC § 168(e)(2), a building is residential rental property (27.5-year) only if 80% or more of its gross rental income for the year comes from dwelling units. If commercial rent is more than 20% of gross rental income, the entire building — apartments included — is nonresidential real property depreciated over 39 years. The test looks at income, not square footage, and it is applied year by year, so a building near the line can actually flip classifications if the rent mix shifts.
This matters enormously for a ground-floor-retail-over-apartments building. If the retail space commands high rents, the 20% commercial threshold is easy to cross, and the whole structure becomes 39-year property. The two-schedule approach makes sense when the residential and commercial spaces are held as separate legal parcels or condominium units, or as separate buildings on one site, because each is then its own asset classified on its own. For a single, unified building, run the 80% test first — it often decides the answer before any allocation is needed.
What counts as a dwelling unit
The 80% test turns on dwelling unit income, and the definition has a trap. A dwelling unit is a house or apartment used to provide living accommodations, but it excludes a unit in a hotel, motel, or other establishment where more than half the units are used on a transient basis. That means short-term-rental and hotel-style income does not count toward the 80% dwelling-unit threshold. A building with apartments upstairs and short-term/transient lodging that dominates the rent roll may fail the residential test and land entirely in the 39-year class. When you have a mix of long-term apartments, short-term units, and commercial space, tally only the genuine long-term dwelling-unit rent when you apply the 80% test.
A worked allocation example
Assume a mixed-use building with an $2,000,000 depreciable basis (land excluded), 75% of rentable square footage residential and 25% commercial, and — importantly — 82% of gross rental income coming from the apartments. Because the dwelling units produce at least 80% of gross rental income, the whole shell is residential 27.5-year property. A cost segregation study identifies $400,000 of components: $250,000 that serves the apartments (fixtures, appliances, apartment-specific finishes), $90,000 that serves the retail space (storefront systems, specialty electrical), and $60,000 of shared land improvements (parking lot, shared lighting, landscaping).
The apartment-specific and shared components tied to the residential operation follow the residential asset lives; the retail-specific components are commercial-use assets. The $60,000 of general land improvements is 15-year property regardless of use, but it is still allocated 75/25 for recapture tracking. With 100% bonus depreciation, the full $400,000 of reclassified 5-, 7-, and 15-year property is deductible in year one, versus roughly $73,000 the same basis would have produced on the 27.5-year schedule. The allocation does not change the year-one deduction much here — it primarily sets up an accurate recapture computation later.
Why the allocation matters most at sale
The reason to insist on a clean residential/commercial split is recapture and gain computation on sale, especially if you ever sell the residential and commercial portions separately or convert one use. The 5- and 7-year components are Section 1245 property recaptured at ordinary rates; the shell and structural components are Section 1250 property with unrecaptured gain capped at 25%; and land improvements are 1250 property that can carry additional depreciation from 150% declining balance or bonus. Without a component schedule that ties each asset to a use and a Code section, your preparer may default to an unfavorable blended split, and an examiner may reach a different one. A study report that separates residential and commercial components, with original costs preserved, is what lets you report the character of the gain correctly and defend it.
Common mistakes and documentation
Three errors recur on mixed-use properties. First, assuming you always split the shell 27.5/39 — for a single building, the 80% gross-rental-income test usually forces one class for the whole structure. Second, counting square footage instead of income when applying the 80% test — the statute measures gross rental income. Third, letting the rent mix drift across the 20% line without noticing that the building's classification (and annual depreciation) can change. Keep a rent roll that separates dwelling-unit income from commercial and transient income, retain the engineer's allocation workpapers and purchase-price allocation, and revisit the 80% test each year for a building sitting near the threshold. Good records here protect both the annual deduction and the eventual recapture split.
Look-back studies and timing for mixed-use owners
You do not have to run the study in the acquisition year. If you already own a mixed-use building and never segregated its costs, a look-back study paired with a Form 3115 accounting-method change lets you claim the entire cumulative missed acceleration as a Section 481(a) adjustment in the current year, without amending prior returns — an especially large one-time deduction now that 100% bonus depreciation has been restored. When you do this on a mixed-use property, insist that the engineer reconstruct the residential and commercial component split as of the original placed-in-service date, because that historical allocation is what the recapture computation will rely on at sale. And because a mixed-use building's classification can turn on the fluctuating 80% income test, confirm the recovery period that actually applied in each year rather than assuming a single life across the whole holding period. Coordinate the timing of the catch-up with a year in which you can absorb the resulting loss under the passive-activity and excess-business-loss rules.
Frequently asked questions
How do I split depreciation between the residential and commercial parts of a mixed-use building?
Use square footage as the default allocation. Components that exclusively serve one use are fully allocated to that use; shared components are split by the residential/commercial sq ft ratio.
Does a mixed-use building always need two separate depreciation schedules?
Yes. The residential portion uses a 27.5-year recovery period, and the commercial portion uses 39 years. These must be tracked separately on your depreciation schedule.
Do land improvements in a mixed-use building get a single 15-year life?
Yes — the 15-year MACRS classification applies regardless of whether the improvement serves the residential or commercial portion, though it must still be allocated between the two for recapture purposes.
Is a mixed-use building always split between 27.5-year and 39-year depreciation?
Not for a single, unified building. Under IRC § 168(e)(2), the whole building is residential rental property (27.5 years) only if 80% or more of its gross rental income comes from dwelling units; otherwise the entire structure is nonresidential (39 years). The two-schedule approach applies mainly when the residential and commercial spaces are separate legal parcels, condominium units, or separate buildings.
How is the 80% test measured — square footage or income?
Income. The statute compares gross rental income from dwelling units to total gross rental income for the year. A building can be mostly residential by square footage yet fail the 80% test if high commercial rents push commercial income above 20%. It is applied year by year, so a building near the line can change classification if the rent mix shifts.
Do short-term or hotel-style units count as dwelling units for the 80% test?
No. A dwelling unit excludes units in a hotel, motel, or establishment where more than half the units are used on a transient basis. Short-term and transient lodging income does not count toward the 80% dwelling-unit threshold, so a heavy short-term component can push a mixed-use building into the 39-year class.
Why does the residential/commercial allocation matter if the year-one deduction is similar?
Because it drives the recapture computation at sale. Section 1245 components recapture at ordinary rates, the Section 1250 shell is capped at 25%, and land improvements can carry additional depreciation. A component schedule tying each asset to a use and Code section lets you report the character of the gain correctly and defend it, and it is essential if you ever sell or convert one portion separately.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.