Bonus Depreciation Recapture: Cost Segregation Before You Sell
Cost segregation and bonus depreciation pull deductions forward, and every fast dollar comes back when you sell. Depreciation on the 5- and 7-year parts a study identifies is recaptured as ordinary income under §1245, and bonus or accelerated depreciation on 15-year land improvements generally comes back as ordinary income under §1250. Either way it is taxed in the year of sale, even on an installment sale (§453(i)). That is the trade: bigger losses now, an ordinary-rate bill at exit. Used well, it can cut both ways in your favor: studies on the rentals you keep can create the very losses that absorb the gain on the one you sell.
Three speeds of depreciation
The book uses one rental in round numbers: a $1 million residential building with $800,000 of depreciable basis.
| Speed | How it works | Year one | Twelve-year total |
|---|---|---|---|
| Straight-line | Residential over 27.5 years (commercial 39), mid-month convention | about $29k, then about $29k a year | about $348k |
| Cost segregation, no bonus | An engineering study moves parts into 5-, 7- and 15-year lives | about $54k, then $78k and $57k, tapering | about $468k |
| Cost segregation + 100% bonus | The short-life parts are written off at once | about $269k, then about $20k a year | about $489k |
Round numbers from the book's example building. Studies often move roughly 20% to 30% of cost into shorter lives, depending on the building (industry estimates, not an IRS figure).
For a passive investor, the bigger the deduction, the more likely it sits unused on Form 8582. A big bonus loss with no passive income to meet it just waits in the reservoir. That is not wasted: it is exactly the kind of loss that sale gain can later absorb (how suspended losses work at a sale).
100% bonus is back for property acquired after January 19, 2025
P.L. 119-21 (the One Big Beautiful Bill) restored 100% bonus depreciation (§168(k)(1)) for property acquired after January 19, 2025. A written binding contract signed before January 20, 2025 fixes the acquisition date and keeps the old, lower rate (P.L. 119-21 §70301(c)(4)). The statute has no phase-down and no placed-in-service deadline, though Congress can always change it. The fine print:
- Only short-life parts qualify: property with a recovery period of 20 years or less. The building shell (27.5 or 39 years) does not.
- Used property qualifies if bought from an unrelated seller (§168(k)(2)(E)(i)).
- Inherited property does not. It is not "purchased" (§179(d)(2)(C)(ii)), though the heir's stepped-up basis starts a fresh schedule and can be cost-segregated.
- 1031 replacements: only basis added with new debt or cash (excess basis) can take bonus on used property; carried-over basis can too only if the replacement is brand new (Reg. §1.168(k)-2(g)(5)(iii)(A)).
- California does not allow bonus (R&TC §17250(a)(11)), so your California losses arrive later and your California gain on sale is different.
The buy-side rules, including who can actually use a bonus loss, are in bonus depreciation on rental property.
The trade: faster losses now, ordinary recapture at sale
When you sell, the depreciation you took comes back in layers:
| Layer | What it is | Rate | Can an installment sale spread it? |
|---|---|---|---|
| Ordinary recapture (§1245, and §1250 on accelerated land improvements) | Depreciation on cost-segregated parts, bonus included | Ordinary, up to 37% | No. Always year one (§453(i)) |
| Unrecaptured §1250 gain | Straight-line building depreciation | Up to 25% | Yes, and it comes out of each payment first (Reg. §1.453-12) |
A simple example: You bought a building for $1,000,000 and took $300,000 of depreciation: $60,000 on 5- and 7-year parts from a cost segregation study and $240,000 of straight-line building depreciation. You sell for $2,000,000 (ignore selling costs), a $1,300,000 gain. The $60,000 is §1245 recapture, taxed as ordinary income in the year of sale, even if the whole price is paid over ten years. The $240,000 is unrecaptured §1250 gain at up to 25%, which rides out with the early payments. The remaining $1,000,000 is long-term capital gain (simple example from the book).
So a study on the building you are about to sell mostly converts future capital gain into near-term ordinary recapture. Unless you will hold for a while, the benefit is usually small. For a passive seller, the recapture is still passive income, so plan year one to meet it with losses you have saved.
The book's Case 12 (an illustrative composite) shows the failure: a remodeled rental with $140k of §1245 recapture, a $300k loan paid off at closing and a high basis. Most of the gain landed in year one no matter how the note was written, and the installment sale was worth little. See when an installment sale won't help.
Look-back study on the rentals you keep
The better use of cost segregation before a sale is usually on other buildings.
If you own rentals you never cost-segregated, a look-back study reclassifies part of each building now. Your CPA files an automatic accounting method change on Form 3115 (designated change number 7, Rev. Proc. 2025-23 §6.01) and takes all the missed depreciation in one year as a §481(a) adjustment. No amended returns. In a passive activity, that catch-up is a passive deduction (Temp. Reg. §1.469-2T(d)(7)(i)), which needs passive income to be used. Sale gain is passive income.
The book's Case 5 is an illustrative composite: a California dentist with five older rentals never cost-segregated sells a sixth for $1.65 million, a $1.13 million gain. A look-back study on the five projects a one-time $380k catch-up and about $45k a year after that. She takes $1.1 million of the price over eight years.
| Plan (Case 5, illustrative, engine output) | Year-1 tax on the gain | 10-year tax on the gain | Ahead after 10 years |
|---|---|---|---|
| Sell for cash | $238k | $238k | (baseline) |
| Installment sale, eight years, level | $8k | $86k | $156k |
| Same structure without the study's losses | $119k |
The catch-up meets the big year-one slice; the smaller yearly slices meet the yearly losses. The study created the losses. The installment sale gave them somewhere to go. Take the catch-up in a year with no sale and it mostly sits on Form 8582. Take it in a cash-sale year and it meets one lump of gain, then the yearly losses wait again. Your numbers will differ.
The reclassified parts on those kept buildings now carry ordinary recapture too. When you sell them, that recapture is due in the year of sale.
Buying the next property with cost seg to create losses for the gain
Another route: sell for cash or on a note, buy another rental with part of the money plus a loan, cost-segregate it and take 100% bonus on the short-life parts. For a passive investor, the new building's first-year loss is passive and so is the gain on the sold rental. They meet in the same year. Because there is no 1031, the whole purchase price is new basis.
If the gain is bigger than one year's new loss, spread the rest on an installment note and let later losses meet later slices. The trade-offs are real: you stay a landlord, you add debt (a loan at about 6.5% costs more than a note paying 4.5%), California gives no bonus, and every bonus dollar comes back as §1245 recapture when that building sells. Borrow for the building, not for the deduction. If the new property is a short-term rental you materially participate in, the loss can be nonpassive instead; see short-term rental tax strategy.
Study quality matters
A cheap study invites audit trouble. The IRS Cost Segregation Audit Techniques Guide (Pub. 5653, rev. February 2025) lists 13 elements of a quality study, requires no specific credentials for preparers, and generally treats an engineer's study as more reliable. A desk estimate is the first thing an examiner will question.
Bottom line
Cost segregation and bonus depreciation move deductions forward and push recapture into the year you sell, at ordinary rates, and an installment sale cannot defer the §1245 piece. On the building you are selling, a new study rarely helps. On the buildings you keep, or one you buy, a study can build the reservoir that an installment sale then drains, year by year. Get both reservoirs modeled, federal and California, and read the depreciation chapter in the free book. The recapture on installment sales guide covers the Form 6252 side, and the waterfall explainer shows the timing.
Questions to ask your CPA
- How much §1245 recapture is in the building I am selling, and do I have cash and losses for it in year one?
- Have any of my other rentals never had a cost segregation study, and what would a look-back catch-up be?
- Should the Form 3115 catch-up be filed for the year of sale?
- If I buy a replacement rental, how much excess basis will it have and what would a study show?
- How do my California numbers differ without bonus?
- If I plan to exchange a cost-segregated building later, will §1245(b)(4) create recapture with no boot? (See depreciation recapture in a 1031 exchange.)
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Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.