If you manage a real estate fund, you already know that depreciation is one of the most powerful tax tools available to your investors. What you might not fully appreciate is how dramatically the rules just changed, and what that means for how you acquire, hold, and communicate the tax benefits of your fund.
The One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, permanently restored 100% bonus depreciation for qualifying property acquired after January 19, 2025. That single change reversed a phase-down that had dropped the rate to 40% in 2025 and was heading to zero by 2027.
For real estate fund managers, this isn’t just a tax update. It’s a shift in how you underwrite deals, structure acquisitions, and pitch your fund to investors. Here’s what you need to know.
What Actually Changed
Under the Tax Cuts and Jobs Act of 2017, 100% bonus depreciation was available for qualifying property placed in service between September 27, 2017 and December 31, 2022. After that, it phased down:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027 and beyond: 0%
The OBBBA wiped out the phase-down entirely. For property acquired after January 19, 2025, 100% bonus depreciation is now permanent. No sunset date. No further phase-down.
The IRS issued Notice 2026-11 on January 14, 2026, confirming that taxpayers can rely on existing TCJA-era regulations with dates updated for the OBBBA. Proposed regulations with full implementation guidance are forthcoming.
There’s one important timing detail: the acquisition date matters. For property acquired under a binding contract signed before January 20, 2025, the old phase-down rates still apply. The 100% rate only kicks in for property acquired after January 19, 2025. If your fund closed on a property in early January 2025 under a contract signed in 2024, you’re likely stuck at 40%.
What Qualifies for Bonus Depreciation
Bonus depreciation under Section 168(k) applies to tangible property with a Modified Accelerated Cost Recovery System (MACRS) recovery period of 20 years or less. For real estate funds, that typically includes:
- 5-year property: Carpeting, appliances, certain fixtures, and some land improvements
- 7-year property: Office furniture, certain equipment
- 15-year property: Land improvements (parking lots, landscaping, sidewalks, fencing), qualified improvement property (QIP)
What doesn’t qualify: the building structure itself. Residential buildings depreciate over 27.5 years and commercial buildings over 39 years. Both exceed the 20-year threshold, so the building shell is not eligible for bonus depreciation.
This is where cost segregation comes in.
Cost Segregation: The Multiplier
A cost segregation study reclassifies components of a building from the 27.5 or 39-year category into shorter-lived categories (5, 7, or 15 years). Once reclassified, those components qualify for 100% bonus depreciation.
For a typical multifamily acquisition, cost segregation might reclassify 20-30% of the building’s depreciable basis into bonus-eligible categories. For a hotel or retail property with significant interior build-out, that number can be higher.
Here’s what that looks like in practice.
Say your fund acquires a multifamily property for $10 million. After subtracting land value ($2 million), you have $8 million in depreciable basis. Without cost segregation, you’d depreciate the entire $8 million over 27.5 years, generating roughly $291,000 in depreciation per year.
With cost segregation, the study reclassifies $2 million into 5 and 15-year property. That $2 million is 100% bonus depreciated in year one. Your first-year depreciation jumps from $291,000 to over $2.2 million. That’s a $1.9 million increase in deductions that flows through to your investors on their K-1s.
For a fund with 20 investors, that additional depreciation could save each LP tens of thousands in taxes in year one, depending on their tax bracket and passive income situation.
How This Flows Through to Your Investors
This is where fund managers need to think carefully. Bonus depreciation creates large first-year deductions, but those deductions flow through to LPs differently depending on their individual tax situations.
Passive Activity Rules Still Apply
For most LPs in a real estate fund, their investment generates passive income and losses. Passive losses can only offset passive income. If an LP doesn’t have other passive income to absorb the bonus depreciation losses, those losses get suspended and carried forward until the property is sold or the LP generates passive income.
This means not every investor benefits equally from bonus depreciation in year one. Your high-net-worth LPs with large passive income portfolios will capture the benefit immediately. Your LP who has one fund investment and no other passive income will carry the loss forward.
Real Estate Professional Status
LPs who qualify as real estate professionals (REPS) under Section 469 can treat real estate losses as non-passive, which means they can use bonus depreciation deductions to offset W-2 income, business income, or any other income type. This is a massive benefit, but most fund LPs don’t qualify for REPS because they’re passive investors.
Short-Term Rental Exception
Some funds invest in short-term rental properties where the average rental period is 7 days or less. Under Section 469, income from these properties is not automatically treated as passive if the LP materially participates. This creates an opportunity for certain investors, but it’s a narrow exception and doesn’t apply to most traditional fund structures.
The bottom line: when you communicate bonus depreciation benefits to your LPs, be specific about who benefits and how. Blanket statements like “our fund generates significant tax losses” can mislead investors who don’t have the passive income to use them.
When Cost Segregation Makes Sense (And When It Doesn’t)
Cost segregation isn’t free, and it doesn’t always make sense. Here’s the decision framework we use with our fund clients.
Do a cost seg study when:
- The property has a depreciable basis of $1 million or more
- The property has significant personal property components (interior finishes, mechanical systems, site improvements)
- Your LPs have passive income to absorb the accelerated deductions
- You plan to hold the property long enough that the depreciation recapture at exit doesn’t wash out the upfront benefit
- The timing of acquisition allows the deduction to be captured in the current tax year
Skip it (or defer it) when:
- The property is primarily land value with a small building
- The depreciable basis is under $500,000 (the study cost may not justify the benefit)
- Your fund is already generating losses that your LPs can’t use
- You’re planning a short hold (under 3 years) where recapture will offset most of the benefit
The cost-benefit math:
A cost segregation study typically runs $5,000 to $15,000 per property depending on size and complexity. For a $10 million acquisition where the study reclassifies $2 million into bonus-eligible property, the cost is negligible relative to the tax benefit. For a $500,000 property where the study might reclassify $75,000, the economics are tighter.
Run the numbers before committing. Your CPA should model the year-one benefit, the impact on each investor class, and the depreciation recapture exposure at exit.
The Recapture Trap
Every dollar of bonus depreciation you take is subject to recapture when the property is sold. This is the part of the conversation that gets less attention than it should.
When your fund sells a property, a portion of the gain is characterized as unrecaptured Section 1250 gain (taxed at up to 25%) to the extent of depreciation previously claimed. If you took $2 million in bonus depreciation in year one, and you sell the property five years later for a gain, that $2 million of accelerated depreciation creates $2 million of additional recapture.
This doesn’t mean bonus depreciation is a bad deal. The time value of money still favors taking the deduction upfront and paying recapture later. But you need to model it honestly when projecting returns to investors.
Here’s the key question: what’s the hold period?
- Long hold (7+ years): Bonus depreciation is almost always a net win. The time value of the upfront deduction outweighs the recapture at exit, especially if the fund executes a 1031 exchange to defer the gain entirely.
- Medium hold (3-5 years): The math is tighter. Model it specifically for your fund. The benefit is real but smaller after recapture.
- Short hold (under 3 years): Bonus depreciation can actually be a net negative if the recapture, combined with the carried interest implications we covered in our carried interest tax guide, creates a worse outcome than standard depreciation would have.
Look-Back Studies: Catching Missed Depreciation
If your fund owns properties that were acquired before the OBBBA and never had a cost segregation study, it’s not too late.
Form 3115 (Application for Change in Accounting Method) allows your fund to “catch up” on missed depreciation in a single tax year. This means you can commission a cost seg study on a property you’ve owned for three years, reclassify components into shorter-lived categories, and take the cumulative missed depreciation as a one-time deduction in the current year.
This is one of the highest-ROI moves available to existing funds. No need to amend prior returns. The entire catch-up hits in one year.
If your fund has two or three properties that never had cost seg studies, the combined catch-up deduction can be substantial. We recommend reviewing every property in the portfolio during your annual tax planning review.
State Conformity: The Hidden Catch
Here’s a complication that trips up many fund managers. Not every state conforms to federal bonus depreciation rules.
Some states require a full or partial addback of bonus depreciation on the state return, even though the deduction is allowed federally. This creates a mismatch: your fund takes a large federal deduction, but your investors in non-conforming states don’t get the state-level benefit and may actually owe more state tax in year one.
Notable examples:
- California requires a 100% addback of bonus depreciation. Your California LPs get zero state-level benefit from bonus depreciation.
- New York partially conforms but has its own depreciation rules for certain property types.
- New Jersey does not conform to federal bonus depreciation.
For a fund with LPs in multiple states, this means K-1 preparation gets more complex. Your investors in conforming states see a large federal and state deduction. Your investors in non-conforming states see a large federal deduction but a smaller (or no) state deduction, plus a potential state tax increase.
Communicate this to your investors before K-1s go out. The last thing you want is an LP calling in April asking why their California taxes went up after you told them the fund was generating “significant tax benefits.”
Section 179 vs. Bonus Depreciation
The OBBBA also increased Section 179 limits. For tax years beginning in 2026, the maximum Section 179 deduction is $2,560,000 with a phase-out threshold starting at $4,090,000.
Section 179 and bonus depreciation both allow accelerated deductions, but they have different rules:
- Section 179 can be elected on an asset-by-asset basis. It cannot create a net operating loss. It applies based on placed-in-service date without a contract date requirement.
- Bonus depreciation applies to all qualifying property by default (unless you elect out). It can create a net operating loss. It requires both the contract date and placed-in-service date to be after January 19, 2025.
For real estate funds, bonus depreciation is typically more impactful because there’s no dollar cap and it can generate losses. But Section 179 can be useful for specific assets where you want to control the deduction amount without an all-or-nothing approach.
Your CPA should model both options for each acquisition.
What This Means for Your Fund’s Value Proposition
Permanent 100% bonus depreciation changes the conversation you have with prospective LPs.
If your fund acquires income-producing real estate and runs cost segregation studies, you can demonstrate specific, quantifiable first-year tax benefits as part of your pitch. For LPs with passive income, this is a real and immediate return on their investment, separate from the fund’s operating returns.
But be honest about the limitations. Not every LP will benefit equally. Passive activity rules, state conformity issues, and depreciation recapture all affect the actual after-tax outcome. The GPs who build trust are the ones who explain the tax benefits accurately, not the ones who oversell them.
Include the depreciation strategy in your investor reporting. Show your LPs what depreciation was taken, how it was allocated, and what the estimated recapture exposure is. This level of transparency differentiates you from every other fund that just sends a K-1 with no context.
Want help modeling bonus depreciation for your fund’s portfolio? Reach out to us and we’ll run the numbers on cost segregation, recapture, and state conformity for your specific situation.
