Cost Segregation for Real Estate Investors
A cost segregation study is an engineering-based tax analysis that reclassifies components of a real estate purchase from 27.5- or 39-year depreciation into 5-, 7-, and 15-year buckets. The result is significantly accelerated depreciation deductions in the early years of ownership, which can be combined with bonus depreciation rules to create large paper losses that offset taxable income. For passive investors in real estate syndications, those losses pass through on the K-1 and can be used to shelter passive income — and in some cases active income for real estate professionals. This guide explains how cost segregation works, what bonus depreciation looks like under current law, when a study is worth commissioning, the tax recapture risk on sale, and how to think about depreciation in the context of multifamily syndications.
Frequently asked questions
What is cost segregation in real estate?
Cost segregation is an engineering-based tax study that reclassifies the components of a real estate property from 27.5- or 39-year straight-line depreciation into shorter 5-, 7-, and 15-year buckets. The result is significantly accelerated depreciation deductions in the early years of ownership, which reduce taxable income and improve after-tax cash flow.
How much can a cost segregation study save?
Cost segregation typically reclassifies 20-35% of a property's depreciable basis into shorter recovery periods. On a $5 million multifamily acquisition, that can mean $1-1.75 million of accelerated depreciation in Year 1 — particularly when combined with bonus depreciation. The actual tax savings depend on the investor's marginal tax bracket and ability to use passive losses.
What is bonus depreciation in 2026?
Bonus depreciation allows investors to immediately deduct a percentage of the cost of qualifying property in the year placed in service. The percentage has been phasing down: 100% in 2017-2022, 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and scheduled to reach 0% in 2027 — unless Congress extends or modifies the rules. Always confirm current law with a qualified CPA.
Can passive real estate investors use cost segregation losses?
Yes — passive losses generated by cost segregation flow through on the K-1 and can offset passive income from the same syndication and from other passive investments. They cannot generally offset W-2 or active business income unless the investor qualifies as a real estate professional under IRS rules. Excess passive losses carry forward indefinitely.
What is depreciation recapture, and is it a problem?
When a property is sold, the IRS "recaptures" some of the depreciation taken — taxing it at ordinary income rates (capped at 25% for real property under Section 1250). Bonus depreciation on shorter-life components is recaptured at ordinary income rates. Recapture reduces but does not eliminate the value of cost segregation, especially when the investor is in a lower tax bracket at sale or rolls the gain forward via a 1031 exchange.
When is a cost segregation study worth doing?
Cost segregation is generally worth doing on properties with a depreciable basis above $500,000-$1,000,000, where the investor can use the resulting losses to offset taxable income, and where the property will be held long enough to justify the study cost ($5,000-$15,000 typical). It's most powerful in the year of acquisition but can also be done retroactively via a Form 3115 catch-up.
Do all LV5 Capital syndications use cost segregation?
Cost segregation is standard practice on most LV5 Capital multifamily acquisitions because it materially improves after-tax investor returns. The decision is made by the sponsor on a deal-by-deal basis depending on property size, tax law, and investor profile. The expected tax treatment is typically disclosed in each deal's Private Placement Memorandum.
Related resources
Read more in our learn library: Real estate syndication · Passive vs active investing · Cost segregation · 1031 exchange alternatives · Multifamily investing 101. Or view our portfolio and schedule a consultation.