If you own investment or commercial real estate in Houston and you’re still depreciating your property on the standard 27.5 or 39-year schedule, you’re almost certainly overpaying taxes by a significant amount. And with the One Big Beautiful Bill Act permanently restoring 100% bonus depreciation in 2025, the opportunity to correct that has never been larger.
The strategy is called a cost segregation study and it’s one of the most powerful, most underused tax tools available to real estate investors. Most Houston property owners have heard of it. Far fewer have actually done one.
At Riley & Company, we work with real estate investors across Houston, The Woodlands, Northwest Houston, and Cypress, and we consistently see the same pattern: properties that have been held for years with significant tax savings sitting unclaimed. Here’s what a cost segregation study actually is, what it can do for your tax position in 2026, and how to know if it makes sense for your portfolio.
A cost segregation study is an engineering-based tax analysis that reclassifies components of a building from the standard depreciation schedule into shorter recovery periods typically 5, 7, or 15 years instead of 27.5 or 39.
When you purchase a property, the IRS generally treats the entire building as a single asset and depreciates it over 27.5 years (residential rental) or 39 years (commercial). But a building isn’t a single asset it’s a collection of components, many of which have much shorter useful lives.
Flooring, specialty lighting, landscaping, parking lots, decorative fixtures, cabinetry, certain electrical and plumbing systems these don’t last 39 years and shouldn’t be depreciated as if they do. A cost segregation study identifies and reclassifies these components into 5, 7, or 15-year property categories, allowing you to deduct them significantly faster.
Typically, 20–35% of a commercial or residential investment property’s cost basis qualifies for reclassification and on larger properties, that number can reach 40% or higher. Our real estate accounting services are built around helping Houston investors capture every advantage the tax code offers including this one.
Before the One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, bonus depreciation was on a scheduled phase-down path dropping to 20% in 2026 and heading toward complete elimination in 2027. Many real estate investors were holding off, either waiting to see what Congress would do or assuming the window had passed.
Under the OBBBA, 100% bonus depreciation was permanently restored for qualified property placed in service after January 19, 2025 with no scheduled phase-down and no sunset. The full details are outlined in IRS Publication 946, which governs how depreciation and bonus expensing apply to business property.
This changes the math dramatically. When a cost segregation study identifies short-life components, 100% bonus depreciation means those reclassified assets can be fully deducted in Year 1 not spread over 5, 7, or 15 years, but written off entirely in the year they’re placed in service.
With 100% bonus depreciation now permanent, cost segregation is no longer a race against a closing window it is a strategy an owner can plan around every year. For 2026, Section 179 also lets business owners deduct qualifying property up to $2.56 million, with the deduction phasing out after $4.09 million of property is placed in service.
The combination of cost segregation + permanent 100% bonus depreciation is the most favorable depreciation environment real estate investors have seen in years.
Let’s put concrete numbers to it. Consider a Houston commercial property purchased for $2 million.
Without a cost segregation study: The property depreciates over 39 years roughly $51,000 per year in depreciation deductions.
With a cost segregation study: A study identifies that 25% of the building ($500,000) qualifies for reclassification to 5 and 15-year property. With 100% bonus depreciation, that $500,000 is deducted entirely in Year 1. The remaining $1.5 million continues depreciating over 39 years.
Year 1 depreciation with cost segregation: $500,000+ vs. $51,000 without it.
At a combined federal and Texas effective tax rate of approximately 30%, that accelerated deduction produces roughly $135,000–$150,000 in tax savings in the first year alone money that stays in the investor’s hands to be redeployed into additional properties, renovations, or debt paydown.
One of the most commonly missed aspects of cost segregation is that you don’t need to have recently purchased the property to benefit.
Look-back studies allow you to claim missed depreciation in a single tax year, providing a substantial catch-up deduction. If you’ve owned a Houston commercial or investment property for several years and never conducted a study, you can still capture all the depreciation you should have been taking claimed in the current year as a single deduction using a Form 3115 accounting method change. There’s no need to amend prior returns.
For many investors, this catch-up deduction is larger than anything they’d generate from a newly acquired property.
Cost segregation works for a wide range of real estate types. According to the IRS Cost Segregation Audit Techniques Guide, qualifying property includes:
The general threshold where a cost segregation study produces a positive return on its cost: a property with a depreciable basis of $500,000 or more. Below that threshold, a less expensive desktop study may still be worthwhile your CPA can model the numbers for your specific situation.
There’s one important nuance Houston real estate investors need to understand: passive activity rules.
For most real estate investors, rental income and losses are classified as passive meaning losses generated by accelerated depreciation can typically only offset other passive income, not W-2 or business income.
However, there are two important exceptions:
Real Estate Professional Status. If you or your spouse qualifies as a real estate professional under IRS guidelines — spending more than 750 hours per year in real estate activities, and more time in real estate than any other profession — your rental losses can offset ordinary income without limitation.
The $25,000 Allowance. If your modified adjusted gross income (MAGI) is under $100,000, you may be able to deduct up to $25,000 of rental losses against ordinary income annually. This allowance phases out between $100,000 and $150,000 MAGI.
Understanding how passive activity rules interact with your specific tax situation is essential before pursuing a cost segregation study and it’s one of the most important conversations to have with your CPA upfront. Our tax planning services include a full passive activity analysis as part of any real estate tax strategy engagement.
A cost segregation study is conducted by a qualified engineering or tax professional not something you or your bookkeeper can do with a spreadsheet. The process typically includes:
The cost of a study typically ranges from $5,000 to $15,000 depending on property size and complexity. For a property where a study generates $100,000+ in first-year deductions, that cost is recouped many times over in the first tax year alone.
Cost segregation is a well-established, IRS-recognized tax strategy with its own Audit Techniques Guide. Studies conducted by qualified professionals and properly documented are defensible. Working with an experienced CPA who understands real estate taxation significantly reduces any audit risk.
You can, but depreciation recapture applies. When you sell a depreciated property, the IRS recaptures previously claimed depreciation at a 25% rate (for Section 1250 property). This doesn’t eliminate the benefit of a study, but it does mean the timing of a sale should factor into the analysis. A 1031 exchange can defer both the gain and the recapture.
Yes, Qualified improvement property (QIP) interior improvements to nonresidential buildings has a 15-year recovery period and is eligible for 100% bonus depreciation under current law. If you’ve made significant renovations, a cost segregation analysis of those improvements alone can generate meaningful deductions.
With 100% bonus depreciation now permanent under the OBBBA, cost segregation isn’t a strategy with a closing deadline. But that doesn’t mean timing is irrelevant. The year you conduct the study, the year you place property in service, and how the deductions interact with your broader tax picture all affect the outcome.
At Riley & Company, we work with Houston real estate investors to model the full cost segregation analysis including passive activity treatment, recapture planning, and the interaction with your overall tax position before recommending a study. If you own investment or commercial property in the Houston area and haven’t explored cost segregation, this is the year to have that conversation.
Contact Riley & Company today and let’s find out what your properties are leaving on the table.
You don’t need to predict the future. You just need to prepare for it.
With smart cash management, thoughtful tax strategy, and the right advisory partner, you can turn uncertainty into opportunity.
