How bonus depreciation actually works (with worked example)

The four-step process

Every Year 1 bonus depreciation deduction flows through the same sequence:

1. Cost segregation — an engineer (or AI-based tool) inspects the property and identifies which components fall into 5-year, 15-year, and 39-year property classes.
2. Basis allocation — the total purchase price is allocated across land (not depreciable), 5-year, 15-year, and 39-year buckets.
3. Apply the bonus depreciation rate — for 2026 purchases, that's 100% on the 5-year and 15-year buckets.
4. Election + Form 4562 — the deduction is claimed on the property's first tax return after placed-in-service.

Step 1: Cost segregation

The IRS doesn't automatically tell you which components are bonus-eligible. Determining that requires a cost segregation study. There are two ways to get one:

Formal engineering study. Performed by a specialty firm (KBKG, Engineered Tax Services, Capstan Tax, etc.). The engineer visits the property, measures everything, and produces an IRS-defensible report. Cost: $5,000–$8,000 for an STR-sized property. Timeline: 4–8 weeks.

AI-based estimate. Tools like DepreciMax use listing photos, county assessor land values, and trained classification logic to produce a calibrated estimate. Cost: $99. Timeline: minutes. Less defensible than a formal study but ideal for screening properties before purchase.

Most experienced STR investors use both — DepreciMax to estimate before making an offer (so they can factor the deduction into purchase price), then a formal study after closing if the deduction justifies the cost.

Step 2: Basis allocation

The total purchase price gets split into four buckets:

Two non-obvious points about land allocation:

• Condos generally carry $0 land basis. Land is shared across the building's units, and most condo associations assign zero land value to individual units. This makes condos extremely tax-efficient for bonus dep purposes.
• Land value isn't just "what the lot would sell for." The IRS uses the assessor's allocation, which is often lower than market value of the dirt alone — particularly in markets where structures appreciated faster than land.

Step 3: Apply the bonus rate

For 2026 (and going forward, under the OBBBA permanent restoration), the bonus depreciation rate is 100% on qualifying property:

The 39-year structural component still depreciates — just on the standard straight-line schedule. In this example, the $390,000 structure produces $10,000/yr in straight-line depreciation ($390k ÷ 39 years). That's a smaller separate deduction that runs every year, not just Year 1.

Step 4: Election and Form 4562

Bonus depreciation is "automatic" — meaning if you don't opt out, it applies. You claim it on Form 4562 (Depreciation and Amortization), attached to your annual tax return. Line 14 reports the bonus depreciation amount.

You can elect out of bonus dep on a class-by-class basis (5-year, 15-year, etc.) by making an election on a timely-filed return. Why would you opt out? Two scenarios:

• You don't have enough income to use the deduction this year, and you'd rather smooth it across multiple years.
• State tax considerations — some states (e.g., California) decouple from federal bonus dep, and electing out for federal might align your federal and state returns more cleanly. Most CPAs still recommend taking the federal benefit and accepting the state mismatch, but this is worth modeling.

What about recapture at sale?

The other side of bonus depreciation: when you sell the property, the depreciation you took is "recaptured" and taxed at the time of sale.

• 5-year property sold at a gain: recaptured at ordinary income rates (up to 37%).
• 15-year property sold at a gain: also recaptured at ordinary income rates.
• Structure (§1250 property): recaptured at unrecaptured §1250 gain rate, capped at 25% — which is usually lower than ordinary rates.

Most investors come out ahead even with full recapture, because: (a) the time value of money on the upfront deduction is significant, (b) recapture rates on 5- and 15-year property are similar to the rates at which you saved tax originally, and (c) 1031 exchanges can defer recapture indefinitely. Run the numbers with your CPA before assuming.