Bonus Depreciation for Real Estate Investors: Are You Using It Correctly?
Originally published on October 28, 2026
“I would rather use a cost segregation to take depreciation to offset 37% tax than 10% tax.” – Kyle Paxton
In this episode of Your CPA’s Take on Real Estate, host Faith sits down with Kyle Paxton to talk about bonus depreciation for real estate investors. Kyle explains why the biggest year-one deduction isn’t always the best one and what investors should think through before they buy.
The conversation covers when to start planning for cost segregation, how tax brackets and hold periods affect the value of a deduction and the questions investors should ask before closing. Kyle also points to state tax rules as a common source of surprises.
If you’re buying a property in 2026 or reviewing a recent purchase, this episode is a practical look at how depreciation fits into the full economics of a deal.
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Episode Transcript
[00:01] Faith: Hi everyone and welcome to the James Moore channel. Today I am here with Kyle Paxton. Hi Kyle, how are you?
[00:01] Kyle Paxton: Hello Faith. Doing well, thanks. Always a pleasure to see you.
[00:01] Faith: A minute. I miss seeing your face. We got to do this.
[00:01] Kyle Paxton: Better things to do than hang out with me, huh?
[00:01] Faith: I know. So today we’re talking about are investors using 100% bonus depreciation correctly. This is a trending topic.
[00:25] Faith: Just moving into the new year, I’ve really been scouring the internet for trending topics that an expert can talk about, because I think this is something important. So the first question is, if you’re an investor buying a property today, when should you start thinking about cost segregation?
[00:46] Kyle Paxton: Oh yeah, Faith, I don’t know. I don’t see that it’s trending because I talk about it every day regardless of whether it’s trending or not. So here we are. So to answer your question, why I talk about it every day is you should start thinking about a cost segregation actually before the close, like when you’re underwriting the deal.
[01:00] Kyle Paxton: This happens before, as part of the deal process. And I think you can see as I answer this, this is what gets me excited, right? But you don’t necessarily need to complete the cost study before closing. In fact, it’s usually done later. And it can be done five years down the line. And there’s procedures for correcting that prior depreciation you’ve taken and taking what’s called a 481(a) catch-up adjustment.
[01:24] Kyle Paxton: But I want to root us in that you’re definitely thinking about it before closing because depreciation does impact the after-tax economics of the investment. We talk about it a lot. I don’t want the tax to get in the way of the economics, but it’s a big piece of the economics. And so this is part of the underwriting conversation and something we want to be on top of from the beginning. And right now, it’s a conversation in just about every real estate deal I come across.
[01:47] Faith: Yeah, absolutely. So, is taking the biggest possible first-year deduction always the best tax strategy?
[01:47] Kyle Paxton: No. No. No. No. And this is, I think, the big misconception, right? And probably the most important thing we’ll discuss today.
[02:06] Kyle Paxton: I hear this all the time, like no question, take it year one. There’s a whole bunch of hoops, right? For a real estate investor, you have a sequence of limitations you have to work through. Do you have basis in the investment? Is that basis at risk? How is that loss treated relative to you as the taxpayer? Do you meet real estate professional status and then materially participate? I’ve already lost half the audience here, but my point is there’s seven different hoops you have to jump through to get it.
[02:35] Kyle Paxton: And then the other thing is, we do a lot of our tax planning around tax brackets, right? We have a progressive tax rate. And as the tax rate scales, the numbers get larger. So I would rather use a cost segregation to take depreciation to offset 37% tax than 10% tax. And if it’s a decision on do I offset 10% tax this year or 37% next year, I’m going to choose 37% next year almost every time, right? I could talk about this for 45 minutes.
[03:10] Kyle Paxton: But there’s a lot of different things we look at here, and that’s a huge misconception, that cost seg year one every time is the way to go.
[03:10] Faith: Absolutely. So, how should investors think about the trade-off between a large deduction today and tax benefits over time?
[03:10] Kyle Paxton: Yeah. Time value of money conversation here.
[03:32] Kyle Paxton: You’re looking at present value versus future flexibility. All else being equal, that deduction today is generally better than the same deduction down the line because you get the cash now and reinvest it. Kind of similar to the last question we just talked through, that all else being equal is kind of doing a lot of work in the response.
[03:55] Kyle Paxton: You think about that tax rate we just talked about, like the ability of when to use the loss, what other items of income look like on your personal return. What other items of income do you expect a year or two down the line on the personal return? How long are you planning to hold this investment? If you’re planning to sell it in two years, it may not make sense to go ahead and take a large deduction this year just to have a large gain next year.
[04:20] Kyle Paxton: And then the sneaky one that gets people all the time is the state trap and state tax implications, and any disconnects between how the states tax depreciation and what you’re seeing on the federal side. So this is all part of the modeling that just goes into that after-tax cash flow we’re talking about.
[04:40] Faith: Absolutely. So when does cost segregation make sense and when might it not be worth doing?
[04:40] Kyle Paxton: This is a little bit of a trickier one, right? My natural inclination is to go to a dollar threshold, but it depends heavily on so many factors that go into it. We’ve just touched on a lot of them. The property itself is going to carry a lot of weight here.
[05:06] Kyle Paxton: What class of property are we looking at? Is the cost segregation actually going to get us that depreciation deduction we’re expecting? What do the other items of income look like? Does that present value of accelerating the depreciation deductions exceed the cost and complexity of doing it? Now I say complexity, but for the real estate investor a lot of times the heavy lift is actually just writing the check to have the cost segregation company do the study.
[05:37] Kyle Paxton: But there is a lot that goes into it from the planning component here. The IRS maintains a detailed cost segregation audit technique guide, which is a good reminder of the mechanics and one that the IRS recognizes, but it’s part of that broader tax planning picture.
[06:00] Kyle Paxton: And you really have to look at the cost versus the benefit. Really, just playing around with the time value of money is what we’re doing.
[06:00] Faith: Absolutely. So, if you’re advising an investor before they close on a property, what tax questions should they be asking?
[06:21] Kyle Paxton: Yeah, it’s a good one, and there’s a lot here. So the first one we always run into is, in a cost segregation, you’re breaking down the building into the individual components, right? Typically you’re buying a building and land. When you’re buying a parcel of real estate, the land is generally not eligible for breaking down the components via cost segregation into classes that qualify for bonus depreciation.
[06:44] Kyle Paxton: So we have that, what’s the building versus the land, to get to our starting point, right? And then of that building component, what portion of that actually falls into those shorter recovery periods? How much depreciation will I get with those shorter recovery periods? Could I actually use that tax loss? We talked about the marginal tax rate.
[07:06] Kyle Paxton: What is that marginal tax rate this year and over the next several years? How long do I expect to hold the property? Does my ownership structure make sense? Is there anyone else involved that’s impacted by this? How does the financing come into play in the tax picture? I think I’m probably at 10 questions now.
[07:23] Kyle Paxton: I could keep going for a while, but there’s a lot that goes into it. And then the last one I want to say again, does the state the property’s in or my investor is located in conform to the federal depreciation rules, or are there any traps there that I’m not considering that could cause surprises?
[07:41] Faith: Yeah, absolutely. So, our last question today is, what’s one thing real estate investors should be doing differently with their tax strategy in 2026, going on to 2027?
[07:41] Kyle Paxton: Yeah. I’ve actually had a couple conversations today where real estate is one of those areas of the tax environment where it’s like zero tax year, zero tax, zero tax, zero tax, boom, big tax surprise, right?
[08:17] Kyle Paxton: And so I think the best tax strategy coming up to 2026, and what I want to key in on, is we’ve had a couple slower deal years where not a ton is moving. I expect things have been kind of steady Eddie from a tax due perspective. I think resetting on the big picture and looking for those big tax surprises is really what I’m looking for with my clients coming into the last two years.
[08:37] Kyle Paxton: And then, we’re talking a lot about cost segregations. It’s a great mechanism to help mitigate tax on those big ticket items. So is there anything we could be doing before year end in that realm to help you offset those?
[08:37] Faith: Absolutely. Well, it was so great talking to you today, Kyle. Thanks for joining me and I cannot wait to have another conversation with you.
[08:56] Faith: Especially moving into the holiday season and going into the new year, it’s always good to have a great financial adviser who gives good wisdom to figure things out.
[08:56] Kyle Paxton: Appreciate you.
[08:56] Faith: Yeah. Thank you.
Watch the Full Episode
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