You finally made it past closing, and the paperwork still feels fresh. This is exactly the right time to start thinking about cost segregation, and whether a California cost segregation study belongs in your first-year tax plan. At this stage, your decisions about depreciation and basis are still in play, and all the key documents an engineer needs are probably still sitting on your desk.
Start with the closing file
Hang on to the settlement statement, the appraisal and the property condition report: You’ll need all of them for a proper study. It’s easiest to ask your lender and agent for copies while you still have everything handy. Pay special attention to how the purchase price is split between land and the building. Only buildings are depreciable, land isn’t, so this number matters a lot. Here’s why:
Consider a client who acquired a California apartment building in 2019 for $5,025,781, with land valued at $3,050,449. A full engineering-based cost segregation study produced an estimated $340,955 in first-year tax savings and a 90:1 payback ratio.
What changes with a study
A study breaks the building into different categories: 5- and 7-year personal property, 15-year land improvements and the main structure. Keep in mind, things like central HVAC, plumbing, roofing and windows are seen as structural components, Section 1250, so they’re on the 27.5- or 39-year depreciation schedule. Only things like stand-alone window units or portable A/Cs fall under Section 1245 personal property.
Bonus depreciation and the changing law
Bonus depreciation turns this reclassification into a big first-year deduction, so the legal climate matters a lot.
The One Big Beautiful Bill Act, P.L. 119-21, made 100% bonus depreciation permanent for qualifying property acquired and placed in service on or after 20 January 2025, reversing the phase-down that had been stepping the rate down through 80%, 60%, 40%, 20% and finally 0%.
California plays by different rules
California doesn’t follow federal bonus depreciation. So, that generous first-year deduction is for your federal return only. You’ll have to add it back on your California return, which means the state tax bill won’t drop by the same amount. California does let you use regular depreciation, so splitting property into shorter depreciation categories still helps. But keep in mind the treatment varies for individuals versus corporations. Always model out both your federal and state returns with a good CPA.
Can you use the deduction?
Before counting on those savings, check if you can even use them right away.
Accelerated deductions are not automatically usable against other income. Under IRC Section 469, losses from rental activity are generally passive, meaning they suspend and carry forward against future passive income, or release on disposition, rather than offsetting wages or business income in the year they arise. At federal level two exceptions apply. Real Estate Professional status under Section 469(c)(7) requires more than 750 hours annually in real property trades or businesses, more than half of total working time, and material participation. Separately, the short-term rental exception under Reg. 1.469-1T(e)(3)(ii)(A) applies where average guest stay is seven days or less and the owner materially participates. California is the important exception here: the state does not conform to Section 469(c)(7), so real estate professional status does not carry over to a California return even where it is established federally. Material participation requires satisfying one of the seven tests in the regulations – most commonly the 500-hour test, or the test requiring more than 100 hours with no other individual participating more.
There is also the exit to consider. Accelerated depreciation is a timing benefit, not a permanent one, and the reckoning comes at sale. The 5- and 7-year personal property a study reclassifies is Section 1245 property, recaptured at ordinary income rates up to 37%. The 15-year land improvements and the building itself are Section 1250 property, where depreciation claimed in excess of straight line is ordinary income and the straight-line portion becomes unrecaptured Section 1250 gain, capped at 25%. Recapture can be deferred through a Section 1031 exchange. This is why hold period matters: a study generally makes sense on a three-to-five-year minimum hold, and is most compelling at five years or longer.
Missed the first year?
You can still do a look-back study if you put the property in service in an earlier year. You’d file Form 3115, which is a change in accounting method, and take a catch-up deduction in the current year, not by amending returns. It’s a nice safety net if you didn’t act in your first year.
Don’t forget, entry prices are high. In June 2026, the median home price in California hit $904,640, and C.A.R.’s Housing Affordability Index put the share of households able to afford the state’s median-priced home at 19% in the second quarter. That keeps rents strong and demand high, but it also means landlords are paying a premium.