Cost Segregation for Real Estate Syndications: Deal-Level Depreciation and LP Losses

For a single investor with a rental, cost segregation is a personal choice. In a syndication it is a partnership decision with dozens or hundreds of affected taxpayers. The partnership owns the property, computes depreciation, makes the elections (IRC 703(b)), and allocates the result under the operating agreement. Investors cannot opt in or out individually.

That makes three questions sponsor questions: whether to commission a study at all, when, and how to treat the results on the return. How a study itself is performed, and what it typically costs, is covered in our main cost segregation study guide. For property-type specifics on multifamily, see apartment building cost segregation.

The 2025 tax law (P.L. 119-21) made 100% bonus depreciation permanent for qualified property acquired after January 19, 2025. IRS Notice 2026-11 provides interim guidance and applies the existing acquisition date rules in Treas. Reg. 1.168(k)-2 with the new date: property is generally acquired when the partnership signs a written binding contract for it, not when it closes.

• Contract after January 19, 2025: 100% bonus on qualified components, whenever placed in service.
• Binding contract on or before January 19, 2025: the prior phase-down applies, generally 40% for property placed in service in 2025 and 20% in 2026.
• Used property: eligible if the partnership did not previously use it and did not buy it from a related party (IRC 168(k)(2)(E)(ii)).
• The building itself: 27.5-year residential rental or 39-year nonresidential property is not bonus-eligible; only property with a recovery period of 20 years or less is.

For the general rules outside the syndication context, see our bonus depreciation guide.

• Electing out of bonus, by class. The partnership can elect out of bonus depreciation for any class of property for the year (IRC 168(k)(7)). Some sponsors do this when the investor base is mostly IRAs or investors unlikely to use passive losses, preferring steadier depreciation over the hold.
• Study now or later. A study can be completed in a later year and the missed depreciation claimed through a change in accounting method, covered in our guide to Form 3115 depreciation catch-up. The catch-up lands on whoever holds interests in the year of change.
• Allocation of depreciation. Most agreements allocate losses in proportion to capital or through target allocations. Allocating depreciation disproportionately to one class must still satisfy the Section 704(b) rules, including the special rules for nonrecourse deductions.
• Section 754 for transfers. When an investor sells an interest mid-hold, a Section 754 election lets the buyer step up its share of the property basis. See Section 754 election.

1. Basis. A partner deducts losses only up to outside basis (IRC 704(d)), which includes the partner's share of partnership liabilities under IRC 752. In leveraged real estate the debt share is usually what makes large first-year losses deductible at all.
2. At-risk. Qualified nonrecourse financing secured by real property generally counts as at risk (IRC 465(b)(6)), so how each loan is classified on K-1 item K matters to investors.
3. Passive activity rules. A limited partner interest is generally treated as passive (IRC 469(h)(2)). Passive losses offset passive income, and unused losses carry forward until the investor has passive income or fully disposes of the interest in a taxable transaction (IRC 469(g)).

Investors who qualify as real estate professionals, or who have other passive income, may get more current use from the losses, but that is an investor-level question their own CPA answers. Our LP-side guide to real estate syndication taxes walks through it from the investor's seat.

The business interest limitation

IRC 163(j) limits business interest deductions to 30% of adjusted taxable income, with a small business exemption. A loss-generating syndication can lose that exemption: a partnership that allocates more than 35% of its losses for the year to limited partners is a syndicate (IRC 1256(e)(3)(B)), which is a tax shelter under IRC 448(d)(3), and tax shelters cannot use the small business exemption. For tax years beginning after December 31, 2024, depreciation is again added back in computing adjusted taxable income, which makes the limit easier to live with.

A real property trade or business can instead elect out of 163(j). The trade-off: it must use the alternative depreciation system for its residential rental property (30 years), nonresidential real property and qualified improvement property, and ADS property is not eligible for bonus depreciation. The 5-, 7- and 15-year components from the study generally remain eligible.

State conformity

Many states do not follow federal bonus depreciation. California, for example, does not allow it. A syndication with property or investors in decoupled states will report different depreciation on state K-1s, and investors will carry separate state basis. Map this when the study is ordered.

On a sale, gain attributable to depreciation on Section 1245 components is ordinary income (IRC 1245), gain attributable to straight-line depreciation on the building is unrecaptured Section 1250 gain taxed at up to 25% (IRC 1(h)(1)(E)), and the rest is generally Section 1231 gain. The allocation of the sale price between the building, its components and land therefore affects every investor's final K-1.

The investor-relations job is to set expectations in the PPM and the first K-1 letter: the deal expects large early depreciation, that depreciation can reduce taxable income during the hold, and part of it is recaptured at exit. If some investors will want a 1031 exchange at sale, see drop and swap and other 1031 exits. For the GP, the same recapture runs through the promote; see how sponsor fees and the promote are taxed.