What Is Bonus Depreciation and How Does It Affect Rental Property?

Bonus depreciation is a federal tax incentive that allows property owners to immediately deduct a large percentage -- or in some cases 100% -- of the cost of qualifying assets in the year they are placed in service. For rental property owners, bonus depreciation dramatically accelerates tax deductions when combined with a cost segregation study, turning decades of gradual write-offs into substantial first-year savings.

The Legal Framework: IRC Section 168(k)

Bonus depreciation is codified under IRC Section 168(k). The Tax Cuts and Jobs Act (TCJA) of 2017 expanded bonus depreciation to 100% for qualifying property placed in service after September 27, 2017, and for the first time extended it to used property (not just new assets). Under the TCJA's original schedule, bonus depreciation was set to phase down: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027.

However, the One Big Beautiful Bill Act (OBBBA), signed into law in 2025, restored 100% bonus depreciation retroactively and made it permanent. This eliminates the phase-down schedule and ensures that qualifying assets can be fully expensed in the year placed in service for the foreseeable future.

What Qualifies for Bonus Depreciation

Bonus depreciation applies to tangible personal property with a MACRS recovery period of 20 years or less. For rental property, this includes 5-year property (appliances, carpeting, certain electrical systems), 7-year property (office furniture, fixtures), and 15-year property (land improvements such as parking lots, sidewalks, fencing, and landscaping). The building structure itself -- classified as 27.5-year residential rental property or 39-year nonresidential property under IRC Section 168(c) -- does not qualify for bonus depreciation.

This is precisely why cost segregation studies are so valuable. Without a study, the entire depreciable cost of a building is placed into the 27.5-year or 39-year category, and bonus depreciation does not apply. A cost segregation study separates qualifying components into shorter-lived categories, unlocking eligibility for bonus depreciation on those reclassified assets.

Impact on Rental Property Owners

Consider a rental property with a depreciable basis of $500,000. Without cost segregation, the annual straight-line depreciation is approximately $18,182 ($500,000 divided by 27.5 years). With a cost segregation study that reclassifies 30% -- or $150,000 -- into bonus-eligible categories, the first-year depreciation becomes $150,000 (bonus depreciation on reclassified assets) plus approximately $12,727 (straight-line on the remaining $350,000), totaling about $162,727. That is nearly nine times the standard depreciation amount.

At a 35% marginal tax rate, the standard approach yields approximately $6,364 in Year 1 tax savings, while the cost segregation plus bonus depreciation approach yields approximately $56,955 -- a difference of over $50,000 in the first year alone.

Used Property Eligibility

One of the most significant changes introduced by the TCJA -- and preserved by the OBBBA -- is the extension of bonus depreciation to used property. Prior to the TCJA, bonus depreciation was limited to new assets (original use had to commence with the taxpayer). Now, an investor who purchases an existing building can perform a cost segregation study and claim bonus depreciation on the reclassified components, even though the property was previously owned and used by someone else.

There is one important restriction: the property cannot be acquired from a related party as defined under IRC Sections 267 or 707(b). Transactions between family members, commonly controlled entities, or other related parties are excluded from bonus depreciation eligibility on used property.

Interaction with Passive Activity Rules

Bonus depreciation generates large deductions, but whether those deductions can be used to offset other income depends on the passive activity loss (PAL) rules under IRC Section 469. For most rental property owners, rental activity is passive, and losses (including depreciation) can only offset other passive income. The two main exceptions are the $25,000 allowance for active participants with AGI under $100,000 (phasing out between $100,000 and $150,000) and the real estate professional status (REPS) under IRC Section 469(c)(7), which requires 750 hours of material participation in real property trades or businesses. Short-term rental owners who materially participate may also treat their rental income as nonpassive, allowing bonus depreciation to offset active income directly.

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This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified tax professional regarding your specific circumstances. AE Tax Advisors, 935 Lake Elmo Dr, Suite B, Billings, MT 59105. Phone: (631) 614-5762.