If you own a multifamily property in California, depreciation may seem simple: establish the tax basis and depreciate the building over its applicable recovery period. Residential rental property generally uses a 27.5-year federal recovery period, but a cost segregation study separates qualifying components into shorter-life categories.
What a study examines
When you work with California cost segregation specialists, professionals typically analyze the property’s physical components alongside construction or acquisition records. The IRS Cost Segregation Audit Techniques Guide, Publication 5653, updated in February 2025, explains how examiners evaluate studies supporting depreciation deductions. It emphasizes identifying individual assets and assigning the correct recovery period based on their characteristics and use.
For a multifamily property, the analysis can cover architectural plans, invoices, construction documents, site information, appliances, carpeting, dedicated electrical components, fencing, parking and landscaping. The point is not to create deductions, but to reclassify existing depreciable basis where the tax rules support shorter recovery periods.
What stays in the 27.5-year category
Not every component qualifies for accelerated treatment. Structural elements and major building components generally remain within the 27.5-year residential rental property category. A roof replacement, for example, does not automatically become five-year property because it appears on a separate invoice; federal guidance generally treats a major roof replacement as a capital improvement to residential rental property. Classification depends on the property’s facts and the applicable rules, not the invoice description alone.
Passive activity limits
IRC Sec. 469 can limit when accelerated deductions actually reduce current taxable income.
Consider a California investor who acquires a residential rental property for $2,400,000, of which $600,000 is allocated to land, leaving a depreciable building basis of $1,800,000. The investor separately purchases $80,000 of furniture, fixtures and equipment. The property is placed in service in January. Without a cost segregation study, the building is depreciated over 27.5 years and the first-year deduction under the mid-month convention is $62,730; the separately purchased FF&E receives 100% bonus depreciation of $80,000 whether or not a study is performed, for a total of $142,730. With a study, $216,000 is reclassified to five-year personal property and $180,000 to 15-year land improvements, giving $396,000 of accelerated basis eligible for 100% bonus depreciation. The remaining $1,404,000 stays on the 27.5-year schedule and produces $48,929 in year one. Adding the $80,000 of FF&E, the first-year deduction is $524,929. The study’s incremental contribution is $382,199, which at a 37% marginal federal rate defers roughly $141,414 of tax.
These deductions are not automatically usable. Under IRC Sec. 469, rental real estate is generally a passive activity and passive losses offset only passive income; unused losses are suspended and carried forward until the taxpayer has passive income or disposes of the activity in a fully taxable transaction. A taxpayer who qualifies as a real estate professional under Sec. 469(c)(7) and materially participates may treat the losses as non-passive. Separately, a rental with an average guest stay of seven days or less is not a rental activity under Reg. Sec. 1.469-1T(e)(3)(ii)(A), so material participation alone can make the losses non-passive without real estate professional status.
Depreciation recapture
Accelerated depreciation is a deferral, not forgiveness. On a taxable sale, depreciation claimed on the five- and 15-year property a study reclassifies is recaptured under IRC Sec. 1245 as ordinary income to the extent of depreciation taken, potentially at rates up to 37%, rather than the 25% maximum applying to unrecaptured Sec. 1250 gain on the building itself. A study therefore shifts part of future gain from Sec. 1250 to Sec. 1245 treatment. The net benefit depends on the time value of the deferral and the expected holding period and is generally weaker for property expected to be sold within a few years.
IRC Sec. 1245 provides the statutory framework for this recapture treatment.
Current federal law
The One Big Beautiful Bill Act (P.L. 119-21), signed July 4, 2025, made the 100% first-year bonus depreciation rate under IRC Sec. 168(k) permanent for qualifying property acquired and placed in service on or after January 20, 2025. Before that change the rate was phasing down on a fixed schedule of 80%, 60%, 40%, 20% and then 0%. Property acquired before January 20, 2025 remains subject to the phase-down percentage in effect at the time of acquisition.
What California changes
California adds another layer because its depreciation rules do not always follow federal treatment. For taxable years beginning on or after January 1, 2025, California generally conforms to the Internal Revenue Code as of January 1, 2025, with modifications. California does not conform to the federal bonus depreciation provisions, so federal and California depreciation schedules can differ.
The practical result is that a cost segregation study can produce different federal and California consequences. Your CPA needs to account for both systems when incorporating the study into your tax filings.
California also does not conform to IRC Sec. 469(c)(7), so for California purposes all rental activities remain passive regardless of real estate professional status.