When it comes to owning rental real estate—whether residential or commercial—understanding depreciation is one of the most powerful ways to unlock significant tax savings. For high-income investors and business owners, proper planning around depreciation can dramatically reduce taxable income, improve cash flow, and even create opportunities to retroactively claim missed deductions.
In this article, we break down depreciation rules, accelerated methods like bonus depreciation and Section 179, and explore how cost segregation studies can offer a major financial advantage—especially if you’re sitting on under-leveraged real estate.
The Basics: Residential vs. Commercial Depreciation
All real estate investors benefit from depreciation, but the rules differ depending on the type of property:
Residential rental property is depreciated over 27.5 years on a straight-line basis. That means if your building cost is $2.75 million, you can deduct $100,000 per year.
Commercial rental property (used for purposes other than primary residence) is depreciated over 39 years.
These standard timelines work well—but often leave money on the table, especially for those looking to supercharge deductions in the early years.
Depreciation Beyond Buildings: Class Lives and Accelerated Recovery
Assets tied to your property but not part of the structure itself (like appliances, equipment, or furniture) follow separate IRS “class lives.” These items may depreciate over 5, 7, or 10 years—much shorter than building depreciation.
Here’s where things get interesting: the IRS allows for accelerated depreciation using the Modified Accelerated Cost Recovery System (MACRS). This system lets you take a larger deduction in early years of an asset’s life, giving your cash flow an immediate boost.
Section 179 vs. Bonus Depreciation: What's the Difference?
To further accelerate deductions, two major provisions come into play:
1. Section 179
For tax year 2025, Section 179 allows you to expense up to $1.25 million of qualifying assets in the first year.
However, the deduction phases out if you purchase over $3 million in assets.
There’s also a taxable income limitation: Section 179 cannot create or increase a business loss. It can reduce your income to zero, but not below.
2. Bonus Depreciation (Section 168(k))
For 2025, bonus depreciation allows you to deduct 40% of the cost of eligible property in the first year—regardless of business income.
Unlike Section 179, bonus depreciation can create a loss, which may be beneficial for offsetting other income.
Pro Tip: For optimal results, many tax professionals recommend this sequence:
Apply Section 179 to reduce taxable income to zero.
Use bonus depreciation to bring taxable income below zero.
Apply standard MACRS depreciation to any remaining cost basis.
Keep an eye on Washington—under the proposed Trump tax plan, 100% bonus depreciation could return, which would significantly enhance these benefits.
The Real Game-Changer: Cost Segregation Studies
If you own income-producing real estate, cost segregation may be your most powerful depreciation strategy.
What is Cost Segregation?
A cost segregation study analyzes your property and breaks down the building’s components to identify portions that qualify for shorter depreciation schedules (typically 5, 7, or 15 years). This allows you to reclassify a portion of the building from a 27.5- or 39-year asset into assets eligible for accelerated depreciation.
What’s the Benefit?
Instead of slowly depreciating the entire value of a property, you might capture hundreds of thousands of dollars in deductions within the first few years—particularly impactful for high-income earners seeking to reduce their tax bill now.
Can You Do It Retroactively?
Yes. If you’ve already placed a property in service in past years, a cost segregation study can still be done. You’ll simply file a change of accounting method (Form 3115) with the IRS. Under Section 481(a), you can “catch up” on all previously unclaimed depreciation in the current tax year.
Example:
Imagine you purchased a $1 million property five years ago. A cost segregation study identifies $150,000 of personal property that should have been depreciated over five years—but you haven’t taken those deductions yet. With a change in accounting method, you can claim all $150,000 in the current year.
Final Thoughts: Don’t Leave Deductions on the Table
For affluent individuals and seasoned investors, strategic depreciation planning isn’t optional—it’s essential. At Neil Jesani Tax Advisors, we help clients implement cost segregation and other advanced tax planning strategies to maximize deductions, improve cash flow, and reduce taxable income.
Our approach combines:
Experienced tax professionals who understand the nuances of accounting changes.
Trusted engineering partners who perform thorough and IRS-compliant cost segregation studies.
Whether you’ve just acquired a new property or you’re holding properties that may be under-depreciated, we’re here to help you unlock the full value of your investment.
FAQs
Q: What is bonus depreciation for 2025?
A: Bonus depreciation for 2025 is currently 40%, but proposed legislation could restore it to 100% under the Trump tax plan.
Q: Can I use cost segregation on a property I bought years ago?
A: Yes, with a change of accounting method, you can retroactively claim missed depreciation and apply catch-up deductions in the current year.
Q: Is cost segregation worth it for residential properties?
A: Yes. Even small reclassifications of building components can create large tax deductions for high-income landlords.
Q: What’s the difference between Section 179 and bonus depreciation?
A: Section 179 is limited to business income and caps out at $1.25 million, while bonus depreciation can create losses and has no dollar cap.
