Why Real Estate Funds Should Act Fast on Cost Segregation in 2025

If you manage a real estate fund with major acquisitions planned for 2025, there's a significant tax strategy that deserves your immediate attention: cost segregation combined with the potential for 100% bonus depreciation. When executed properly, this approach not only saves you tax but also creates liquidity, improves fund performance, and delivers better returns for your investors.

With potential legislation to reinstate 100% bonus depreciation for 2025 and early indicators of softening real estate prices, preparation is critical.

Why 2025 Is a Unique Opportunity

Bonus depreciation was introduced in its current form through the Tax Cuts and Jobs Act (TCJA), allowing businesses to deduct 100% of the cost of certain qualified property in the year it’s placed in service. 

While the original law called for a gradual phase-out—80% in 2023, 60% in 2024, and 40% in 2025—recent proposals suggest that full 100% expensing could be extended or reinstated for properties placed in service in 2025.

That one change could unlock enormous tax benefits for funds making multimillion-dollar property acquisitions. But whether it’s officially restored or not, cost segregation remains the key to unlocking bonus depreciation, whatever the rate ends up being.

A Unique Market Opportunity

Beyond the tax implications, we're seeing early signs of weakness in real estate prices. This convergence of tax benefits and market conditions creates a rare dual opportunity for strategic fund managers.

Understanding Cost Segregation

At its core, cost segregation is an IRS-approved tax method that separates the components of a building, like lighting, flooring, plumbing, and paving, into different asset classes with shorter useful lives. Rather than depreciating the full building over 27.5 or 39 years, these components can often be depreciated over 5, 7, or 15 years.

Why does this matter? Because those shorter-life components qualify for bonus depreciation, meaning you can write off 100% (or at least a large percentage) of their value in the year they're placed in service. 

In practical terms, this means millions in tax deductions that would otherwise take decades to realize.

The Process and Timing

A question we are often asked is whether or not it matters to get a cost segregation study done in the year of purchase. The truth is that it doesn't. However, it does matter to have the study done prior to filing the tax return, in which these assets are placed in service for the purpose of taking advantage of bonus depreciation.

The Financial Impact on Real Estate Funds

Case Study: $30 Million Commercial Property Acquisition

Property Details:

• Purchase price: $30 million
• Property type: Commercial
• Entity structure: Pass-through (LLC/LP)

Cost Segregation Results:

• Components reclassified: 25–40% of property value
• Dollar amount reclassified: $7.5–12 million
• Bonus depreciation rate: 100% (proposed)
• First-year deduction: Up to $12 million

Tax Savings Impact:

• Combined tax rate: 40% (federal and state)
• Immediate tax savings: $4.8 million
• Benefit type: Direct flow-through to investors

Fund Performance Improvements:

• Enhanced after-tax returns
• Increased IRR
• Competitive advantage in capital markets
• Superior LP distributions

This real-world example demonstrates how cost segregation can transform a standard acquisition into a tax-advantaged investment that significantly outperforms traditional depreciation strategies.

What Qualifies for Bonus Depreciation?

To take advantage of bonus depreciation, assets must:

• Have a useful life of 20 years or less [as determined under Modified Accelerated Cost Recovery System (MACRS)]
• Be new or used (as long as it's your first time using it)
• Be placed in service during the applicable tax year

Cost segregation is what allows you to properly identify and support those assets, from decorative finishes and removable partitions to specialized electrical systems and site improvements.

Retroactive Studies: Don't Let Past Acquisitions Go to Waste

If you purchased properties in 2024 (or even earlier) and didn't conduct a cost segregation study, there's still time to catch up. The IRS allows for retroactive cost segregation using Form 3115, which lets you claim missed depreciation as a "catch-up" deduction—all in the current year.

This can be a particularly effective strategy in 2025 if you want to offset large gains or income spikes, or if you're seeking to create immediate tax losses to distribute to investors; however, it will still not allow the same advantage of bonus depreciation as a retroactive deduction.

What's Actually Reclassified?

Some of the most commonly reclassified items in a commercial property include:

Land Improvements

• Sidewalks and parking lots
• Tennis courts and swimming pools
• Signage and fencing
• Site lighting and retaining walls

Interior Components

• Doors, cabinetry, and decorative trim
• Carpet, tile, and specialized flooring
• Removable ceiling tiles
• Solar energy installations

Equipment and Systems

• Appliances (refrigerators, washers/dryers, ovens, dishwashers)
• Lighting fixtures
• Specialized plumbing (e.g., kitchen or lab piping)
• Specialty HVAC or ventilation systems

Depending on the asset type, a well-executed study can reclassify up to 40% of a property's cost to short-lived property. That's not an edge case—that's the average for some industries like hospitality, healthcare, and industrial.

IRS Compliance Requirements

The IRS has clear expectations around what qualifies as a "quality" cost segregation study, as outlined in their Audit Technique Guide (ATG) Publication 5653. These include:

• Detailed engineering-based analysis
• Clear cost breakdowns supported by construction or purchase documentation
• Legal rationale with relevant tax code citations
• Reconciliation to total property basis

Using shortcuts, like rule-of-thumb percentages or templates without backup, can put your entire deduction at risk during an audit. This is especially important for funds claiming large deductions. The more aggressive your write-off, the more important it is that your documentation holds up.

Strategic Timing: Why Acting Early Matters

If 100% bonus depreciation returns for 2025, this could be the last year to fully expense qualified property. Details about extension into 2026 or beyond have not yet been formally clarified in legislative text.

Waiting until Q4 to engage a cost segregation provider or complete your acquisitions could leave you scrambling to meet the placed-in-service requirements. Demand for qualified providers typically spikes in fall, especially among institutional investors and funds. If you wait, you may miss your window.

Avoiding Common Pitfalls

Here are a few issues that can derail your strategy, if not handled properly:

• Double-counting FF&E purchased separately from the property
• Failing to allocate indirect costs like permits, design fees, or legal expenses
• Missing energy-related incentives, such as those available under the Inflation Reduction Act
• Incorrectly classifying structural components
• Not filing Form 3115 for retroactive deductions

The solution? Coordinate early between your internal team and external specialists—CPAs and cost segregation professionals working together. 

At SponsorCloud, our team of CPA and cost segregation specialists can help you navigate this coordination, ensuring nothing falls through the cracks when millions in tax savings are at stake.

Your Action Plan for 2025

If you're already planning an acquisition, development, or renovation, here's what to do now:

Start Early with Projects

Start the permitting phase and capital calls for planned projects. Expedite projects already underway. Bonus depreciation applies to the year placed in service—often the same timeline as your certificate of occupancy for renovations and developments.

During Underwriting

Begin the cost segregation process pre-close. Early modeling influences purchase decisions and helps structure deals.

Choose the Right Partner

Work with a qualified provider that uses engineering-driven studies. Quality matters when millions in tax savings are at stake. At SponsorCloud, our team combines deep real estate fund expertise with rigorous engineering methodology, ensuring your cost segregation studies meet IRS standards while maximizing your legitimate deductions.

Model Multiple Scenarios

Model your depreciation scenarios to understand the tax and cash flow impact at both the fund and LP levels. SponsorCloud can help with this modeling, or work with your existing CPA to run multiple scenarios based on different bonus depreciation rates.

Monitor Legislation

Track bonus depreciation legislation closely. If 100% is reinstated, move quickly to finalize placements in service.

Document Everything

Track everything—building blueprints, specs, site photos, and indirect costs. Thorough documentation supports your deductions.

The Bottom Line

If you're in the business of acquiring or developing real estate in 2025, cost segregation and bonus depreciation aren't just "nice to have" tools—they could be your secret weapon for maximizing investor returns, freeing up capital, and creating tax efficiencies across the board.

With potential changes to bonus depreciation on the horizon, this may be your last, best chance to take full advantage of immediate expensing. But to benefit, you'll need to plan, execute, and document your strategy well before the clock runs out.

Important Disclaimer

Given the legislative uncertainties, it's advisable to consult with tax professionals to assess how these proposed changes might impact your specific situation and to develop strategies that align with both current laws and potential future adjustments.

Want to know how much tax savings are possible for your next deal?‍
‍Book a call with us to walk through the numbers and get clarity on what this could mean for your fund and your investors.