Buying investment property usually comes with a specific kind of euphoria. You sign the papers, get the keys, and start calculating the cash flow. But there is a silent partner in every deal who shows up every April, hand outstretched: the IRS.
For many investors, taxes are just a painful reality, a cost of doing business that eats into margins. But the smartest operators view the tax code differently. They see it as a rulebook where, if you know which levers to pull, you can legally keep more of what you earn.
The Depreciation Lever
Most people understand the basic concept. The government acknowledges that buildings don’t last forever. Roofs leak, pipes burst, and structures age. To account for this wear and tear, the IRS lets you deduct a portion of the building’s value every year. If you own a commercial building, you typically spread that deduction over 39 years. For residential rentals, it’s 27.5 years.
Speeding Up the Clock
The problem with standard depreciation is the timeline. Waiting nearly four decades to fully write off a building is slow. This is where cost segregation changes the math.
A building isn’t just a single block of concrete. It’s a container for thousands of different assets. The carpeting, the security cameras, the specialized lighting, the parking lot pavement—none of these things last 39 years. A cost segregation study sends engineers into your property to identify these components and reclassify them. Instead of a 39-year life, these items might have a 5, 7, or 15-year life.
Why does this matter? Because it lets you front-load your deductions. Instead of a small tax break every year for decades, you get a massive tax break right now.
The “One Big Beautiful Bill” Effect
Things got even more interesting with recent legislative changes. The “One Big Beautiful Bill Act” made 100% bonus depreciation permanent. This is a game-changer. Bonus depreciation allows you to take those reclassified assets and write off their entire value in year one. If you buy a multifamily complex and identify $500,000 worth of “Section 1245 property” (things like appliances and fixtures), you don’t depreciate that $500,000 over time. You deduct it all immediately.
The Hidden Trap in the Exit
However, there is no such thing as a free lunch. The IRS has a long memory. When you sell that property down the road, the government wants to “recapture” that depreciation. They effectively say, “We let you take a deduction early, but now that you sold the asset for a profit, you owe us tax on that gain.”
Most investors rely on the 1031 exchange to dodge this. The logic is simple: roll the money into a new building, defer the tax. But this is where people get hurt. A 1031 exchange defers capital gains, but it doesn’t automatically fix the issue of Section 1245 recapture.
If you sell a building heavily loaded with personal property (where you took aggressive bonus depreciation) and trade into a property that has very little personal property, you have a mismatch. You haven’t replaced the specific type of asset you sold. The IRS can step in and tax you on that difference at ordinary income rates, which is significantly higher than the capital gains rate.
This nuance is often missed until the tax bill arrives. Understanding bonus depreciation recapture is the only way to ensure your “tax-free” exchange doesn’t trigger a five-figure liability. You have to look at the composition of the new building, not just its price tag.
Accelerating Wealth
Depreciation isn’t just an accounting entry; it’s a strategy. Used correctly, it accelerates wealth building by keeping capital in your hands to reinvest. But it requires foresight. You can’t just aggressively strip equity out of a property through tax breaks without a plan for how you’ll eventually exit. The goal isn’t just to lower taxes today, but to ensure you don’t give it all back tomorrow.
