Cost Segregation for Physicians: Tax Planning to Accelerate Real Estate Depreciation (2026 Update)
Updated: Oct 9
Updated September 2026 to reflect current tax laws, including the 2025 restoration of 100% bonus depreciation.
You bought a rental property. Somewhere between the closing and your first tenant, a colleague told you about cost segregation and said it would "wipe out your tax bill." Then you asked your tax team, and the answer came back as a question: can you actually use the loss?
That question is the whole story for physicians. The deductions are real, and under current law they are larger than they have been in years. But a paper loss only helps if the tax code lets it reach your clinical income.
This guide covers how cost segregation works and what it is worth for a property acquired in 2026. It then gets to the parts the general guides skip: the rules that decide whether you can use the loss, what changes when you own your own office building, how to catch up on a property you already own, and what the bill looks like when you sell.
Nothing here is investment advice. We are not telling you to buy real estate. We are explaining how the tax code treats it if you do.
In This Blog
What is cost segregation and how does it accelerate tax savings?
How much can a physician actually defer? Dr. Patel's fourplex
Can a physician actually use the losses? The passive activity rules
Should you use cost segregation for your own medical office building? Dr. Nguyen's practice
What are the downsides? Recapture and when cost segregation backfires
What is cost segregation and how does it accelerate tax savings?
When you buy a rental property, the tax code treats the building as one asset that wears out slowly. A residential rental depreciates over 27.5 years and a nonresidential building, like a medical office, over 39 years. Land never depreciates at all.
Those recovery periods come straight from IRC section 168(c).
A cost segregation study challenges the "one asset" idea. In the IRS's own words, from its Cost Segregation Audit Techniques Guide, these studies "involve the allocation (or reallocation) of the total cost (or value) of property into the appropriate property classes and recovery periods in order to properly compute depreciation deductions."
Translated: an engineer walks the property and sorts it into pieces that the tax code depreciates at different speeds.
What gets pulled out of the building?
What a study commonly pulls out:
5-year property: carpet, appliances, some cabinetry and millwork, decorative lighting, dedicated electrical and plumbing that serves equipment rather than the building.
7-year property: certain furniture and fixtures.
15-year property: qualified improvement property, meaning an interior improvement to a nonresidential building made after the building was first placed in service, per IRC 168(e)(6). Land improvements such as sidewalks, fences, drainage, and landscaping are 15-year property as well, under asset class 00.3 of Rev. Proc. 87-56 as described in Rev. Rul. 2003-81.
27.5-year or 39-year property: the structural shell, roof, walls, and the systems that serve the building as a whole.
How much moves into the short buckets depends entirely on the property. A furnished short-term rental with a pool and a paved lot looks nothing like a bare shell office suite.
No official source publishes a "typical" percentage, so treat any number a vendor quotes as a sales estimate. In the examples below we assume a share and label it as an assumption.
Why does the IRS care who does the study?
The same IRS guide says "a study by a construction engineer is more reliable than one conducted by someone with no engineering or construction background." That is your signal on quality.
A study that will survive an audit documents how each component was identified and valued. A spreadsheet that applies a percentage to the purchase price is not that.
How does bonus depreciation work under current law?
Cost segregation moves cost into short-lived buckets. Bonus depreciation is what lets you deduct those buckets all at once, and this is where the 2025 law changed the math.
Public Law 119-21, signed July 4, 2025, rewrote IRC 168(k) so that the first-year allowance for qualified property is 100% of adjusted basis. IRS Publication 946 (2025) puts it plainly: the law "reinstated the 100% special depreciation allowance for certain qualified property acquired and placed in service after January 19, 2025."
The IRS describes the deduction as permanent in its January 2026 guidance release. The year-by-year phase-down that dominated planning from 2023 through early 2025 is gone for new acquisitions.
Two things to keep straight:
Bonus depreciation applies to the 5-, 7-, and 15-year property a study identifies. It does not apply to the 27.5-year or 39-year shell, so a plain building with no study has almost nothing to bonus.
The test is when you acquired the property under the acquisition-date rules, not just when you closed or placed it in service. Contract dates matter, and your tax team confirms which side of January 19, 2025 you fall on.
A used building qualifies. Under IRC 168(k)(2)(E)(ii), the property must not have been used by you at any time before you acquired it, and the purchase has to meet the statute's other acquisition conditions, which is why both examples below assume an existing building bought from someone else.
What if I bought before January 20, 2025?
Then that property is still under the old phase-down. The 2025 Instructions for Form 4562 put it this way: "Certain qualified property (defined below) acquired after September 27, 2017, and before January 20, 2025 (other than property with a long production period and certain aircraft), is limited to a special depreciation allowance of 40% of the depreciable basis of the property." That 40% figure is for property placed in service in 2025.
If a pre-2025 contract property was placed in service in 2026, the old schedule sets its own percentage for that year. Your tax team confirms the figure.
There was also a one-time choice. IRC 168(k)(10) let a taxpayer elect 40% instead of 100% (60% for certain long-production property) for property placed in service in the first taxable year ending after January 19, 2025.
Some physicians used that election to push deductions into years where they could use them. It is an election made on the return, not a default.
Does my state follow federal bonus depreciation?
Often not. Bonus depreciation is a federal rule, and states decide for themselves.
California is the clearest example. The Franchise Tax Board's 2025 depreciation instructions list "IRC Section 168(k) relating to the depreciation deduction for certain assets" among the federal provisions California law does not conform to, and the individual adjustment form, FTB 3885A, carries a line for exactly that difference.
A California physician who takes a large federal deduction in year one will depreciate the same property under California's own rules on the state return. The two schedules diverge for years.
Other states have their own answers, and they change. Ask your tax team to confirm your state before you count on the state tax savings.
How much can a physician actually defer? Dr. Patel's fourplex
Here is the math on a hypothetical purchase in 2026. Every number is an assumption for illustration; your property, allocation, and bracket will differ.
Dr. Patel, an anesthesiologist, and her spouse file jointly in the 37% federal bracket. For 2026 that bracket begins at $768,700 of taxable income for joint filers under Rev. Proc. 2025-32. She buys a fourplex:
Purchase price: $1,200,000
Allocated to land (not depreciable): $240,000
Depreciable basis: $960,000
Option A, no study, straight-line over 27.5 years:
Annual depreciation: $960,000 / 27.5 = about $34,900 (a full year; the first year is prorated by the month placed in service)
Option B, cost segregation study plus 100% bonus depreciation, assuming the study reclassifies 30% of basis:
Reclassified to 5-, 7-, and 15-year property: $288,000, deducted in full in year one
Remaining building shell: $672,000 / 27.5 = about $24,400 (again a full year; prorated in year one)
Depreciation in year one: about $312,400
If the fourplex nets $60,000 of rental income before depreciation, Option A leaves about $25,100 of taxable rental income. Option B produces a rental loss of roughly $252,400.
At a 37% marginal rate, a usable $252,400 loss could potentially defer around $93,000 of federal tax in year one. That is the number the seminar speakers quote.
It is also the number most physicians never see, for the reason in the next section.
Can a physician actually use the losses? The passive activity rules
IRC section 469 says "the term 'passive activity' includes any rental activity." A passive loss offsets passive income. It does not offset your W-2 from the hospital or your 1099 from the surgery center.
Dr. Patel's $252,400 loss, by default, sits suspended on Form 8582 until she has passive income or sells the property.
There are three ways out, and one of them almost never works for a practicing physician.
Why doesn't the $25,000 allowance help me?
Section 469(i) lets an individual who actively participates in rental real estate deduct up to $25,000 of rental losses against other income. Then it takes the allowance away.
The $25,000 is reduced "by 50 percent of the amount by which the adjusted gross income of the taxpayer for the taxable year exceeds $100,000." Run that arithmetic and the allowance hits zero at $150,000 of AGI, and the figures are not indexed for inflation.
For most attending physicians, this exception was designed for someone else.
Can my spouse qualify as a real estate professional?
This is the path most physician households use. IRC 469(c)(7)(B) turns off the automatic passive label for someone who meets two tests in the same year:
More than one-half of the personal services you perform in all trades or businesses are performed in real property trades or businesses in which you materially participate, and
You perform more than 750 hours of services in those real property trades or businesses.
A full-time physician fails the first test on arithmetic alone. The statute adds a door, though: "In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements."
If your spouse runs the real estate as their primary work and clears both tests on their own, the household qualifies. Hours cannot be pooled between spouses.
The qualifying spouse still has to materially participate in the rentals themselves, or make the election to treat all rentals as one activity. The regulations let you prove your hours by any reasonable means, but a log kept as you go is far easier to defend than a reconstruction after the fact.
Our real estate professional status guide walks through the tests, and the REPS requirements post covers the documentation.
What about the short-term rental exception?
The passive activity regulations carve out property that does not behave like a long-term rental. Treas. Reg. 1.469-1T(e)(3)(ii) says an activity is not a "rental activity" if "the average period of customer use for such property is seven days or less," or if the average stay is 30 days or less and the owner provides significant personal services.
A short-term rental that meets that test is not a rental activity for section 469 purposes, so the real estate professional tests do not apply to it. You still have to materially participate.
The two most commonly used material participation tests in Treas. Reg. 1.469-5T(a) are participating "for more than 500 hours during such year," or for more than 100 hours and "not less than the participation in the activity of any other individual." That last phrase includes your cleaners and any property manager.
Pair a cost segregation study with a qualifying short-term rental and the loss in year one can be nonpassive without anyone in the household leaving medicine. That combination is what people mean by the short-term rental loophole.
Our comprehensive short-term rental guide covers the traps, starting with personal-use days.
Two more ceilings: the excess business loss limit and the 3.8% tax
Even a nonpassive loss runs into two more rules.
IRC 461(l) caps the net business loss a noncorporate taxpayer can deduct against other income in a single year. For taxable years beginning in 2026, Rev. Proc. 2025-32 sets the threshold at $256,000, or $512,000 on a joint return.
The 2025 law made this limit permanent and reset the inflation base, which is why the 2026 figure is lower than 2025's. Any loss above the cap is not lost; it becomes a net operating loss carryover.
Dr. Patel's $252,400 fits under the joint cap. A larger property, or two studies in one year, can hit it.
The second rule arrives once the property turns profitable. Net rental income from a passive rental generally carries the 3.8% net investment income tax under IRC 1411 above $200,000 of modified AGI for single filers or $250,000 for joint filers. Those thresholds are not indexed, so nearly every physician household is over them.
Should you use cost segregation for your own medical office building? Dr. Nguyen's practice
This is the case none of the general cost segregation guides address, and it is the one physicians ask us about most.
Dr. Nguyen, a dermatologist, files as a single taxpayer and owns her practice as an S corporation. She also owns the building through a separate LLC and leases it to the practice.
A study on that building looks like an obvious win. Two rules complicate it.
What does the self-rental rule do to the loss?
Treas. Reg. 1.469-2(f)(6) provides that net rental income from property "rented for use in a trade or business activity" in which you materially participate "is treated as not from a passive activity."
The regulation recharacterizes income. It says nothing about losses, so a net loss from the same building stays passive under the default rule.
The rule works in one direction. Profits from renting to yourself are nonpassive and cannot be sheltered by other passive losses, while a cost segregation loss from the same building can be trapped as passive.
Assume the building cost $2,000,000 with $400,000 allocated to land, the study reclassifies 35% of the $1,600,000 depreciable basis, and the practice pays $150,000 of net rent:
Bonus depreciation on reclassified components: $560,000 in year one
Shell depreciation: $1,040,000 / 39 = about $26,700 (full year)
Net rental loss in year one: roughly $436,700
Under the self-rental rule alone, that loss is passive. Dr. Nguyen's practice income is nonpassive. They do not meet.
Can the grouping election fix it?
Possibly. Treas. Reg. 1.469-4 allows activities to "be treated as a single activity if the activities constitute an appropriate economic unit."
A rental can be grouped with a trade or business only in limited cases. One of them is where "each owner of the trade or business activity has the same proportionate ownership interest in the rental activity." Dr. Nguyen owns 100% of both, so she may be eligible to treat the building and the practice as one activity in which she materially participates.
If the grouping holds, the building's loss is nonpassive and the excess business loss limit takes over. That limit is applied to her net business result, so the practice's K-1 income offsets the building loss first. Only a net business loss above the 2026 threshold for single filers of $256,000 is disallowed for the year and carried forward as an NOL.
Her W-2 wages from the practice stay out of that netting. The statute excludes income from performing services as an employee.
The grouping election has disclosure requirements and has to be consistent year to year. It turns on facts your tax team needs to review before the study is commissioned, not after.
Do the planning first. The engineer's report is the easy part.
Already own the property? The look-back study
If you have owned a rental for several years and depreciated the whole thing over 27.5 or 39 years, a study can still be done. The catch-up does not require amending prior returns.
A change from straight-line on the whole building to the component method is a change in accounting method. Rev. Proc. 2025-23, the current list of automatic changes, includes a change "from an impermissible to a permissible method of accounting for depreciation or amortization."
You file Form 3115 with the current year's return. Per the Form 3115 instructions, "ordinarily, an adjustment under section 481(a) is required for accounting method changes." That adjustment is what lets you take the depreciation you missed in prior years as a single catch-up deduction in the year of change.
The instructions also confirm that "no user fee is required for a Form 3115 filed under the automatic change procedures."
Three cautions:
The catch-up puts the missed depreciation into one year, so the passive loss and excess business loss rules above apply to that year with full force.
The bonus percentage that applies to the components is the one in effect when the property was originally acquired and placed in service. A look-back study does not give a 2019 purchase the 2026 rule.
Your tax team confirms the specific automatic change number and eligibility rules in the revenue procedure before filing.
What are the downsides? Recapture and when cost segregation backfires
Cost segregation is a timing tool. It accelerates deductions you would otherwise have taken over decades, and the tax code collects when you sell.
Do you have to pay back cost segregation?
Not in the sense of a repayment, but yes in the sense of recapture.
IRC 1245(a)(1) provides that gain on the sale of section 1245 property, which covers the 5- and 7-year personal property you deducted with bonus, "shall be treated as ordinary income" to the extent of the depreciation you took. That is your marginal rate, up to 37% federal, not the capital gains rate.
The 15-year property is real property, so it falls under IRC 1250 instead. Depreciation on it above what straight-line would have allowed is "additional depreciation," and that amount is also taxed as ordinary income when you sell.
The building shell gets a third treatment. Straight-line depreciation on real property creates "unrecaptured section 1250 gain," which IRC 1(h)(1)(E) taxes at up to 25%.
Whatever gain remains is long-term capital gain. The 3.8% net investment income tax can apply on top of all of it for a passive owner, and state tax is separate.
Back to Dr. Patel. If she sells the fourplex after five years for a gain, the $288,000 she deducted on the reclassified components is exposed to ordinary income recapture first (under section 1245 for the 5- and 7-year items and section 1250 for the 15-year items), then the shell depreciation at up to 25%, then capital gain on the rest.
She deferred tax at 37% and may pay some of it back at 37%. Holding those tax dollars for five years has value, but it is a deferral, not a discount.
When is cost segregation a bad idea?
You plan to sell within a few years. The recapture arrives before the deferral has done much work.
You cannot use the loss. If neither the real estate professional nor the short-term rental path is realistic for your household, the loss in year one sits suspended, and you paid for a study to create it.
You are in an unusually low-income year. A residency or fellowship year, or a sabbatical, is the wrong time to accelerate deductions.
Your state decouples. If you live in California, the federal benefit is real but the state benefit is not, so the total is smaller than the seminar math.
The fee eats the benefit. Study fees vary by property and provider. On a small or land-heavy property, the fee can approach the present value of the deferral. Ask for the fee before you ask for the study.
A 1031 exchange, or holding the property until it passes through your estate, changes the recapture analysis. Those are tax mechanics your tax team can model. They are not reasons to buy or hold anything.
DIY software or a professional engineering study?
Two paths exist. Online tools generate a component allocation from your inputs at a low fee, while engineering firms send someone to the property, review construction documents, and produce a report with a methodology the IRS recognizes.
The difference shows up in the file. An engineering report walks the property room by room, ties each component to a cost from the closing statement, appraisal, or construction records, explains the classification method it used, and is signed by someone who can defend it in an exam. A software allocation gives you a percentage split and a disclaimer.
The IRS's own guide describes the detailed engineering approach from actual cost records as the most accurate method. It also says an engineer's study is more reliable than one done without that background.
Our view: for a small residential rental with a modest basis, a well-documented software study can be defensible. For a commercial building, a medical office, a high-basis short-term rental, or anything you expect the IRS to look at closely, pay for the engineer.
What you are buying is the file you hand an examiner. Fee levels are commercial and vary, so we do not quote them here.
Is cost segregation right for you? A physician checklist
Run through these before you call a vendor:
Can you use the loss? Real estate professional status through a spouse, a qualifying short-term rental with material participation, other passive income, or (for a self-rented building) a grouping election your tax team has reviewed. If the answer is none of these, stop here.
Is the depreciable basis large enough for the fee to make sense? There is no legal threshold. In our experience the answer depends on basis, allocation, and your bracket, and your tax team can run the numbers.
When will recapture land? A sale within a few years puts the recapture bill right behind the deduction.
Will the loss fit under the 2026 excess business loss cap of $256,000 ($512,000 joint), or will part of it carry forward?
Does your state conform? Most states do not.
Is this a high-income year where each dollar of deduction is worth up to 37 cents of federal tax, or a low one?
Already own it? Ask about a look-back study and Form 3115 rather than assuming you missed the window.
Depreciation schedules were not in the curriculum in medical school, and they should not be your weekend reading either. That is what your tax team is for.
Talk to your tax team before you commission the study
The physicians who benefit most from cost segregation are the ones who answer the passive loss question and the exit question before the engineer shows up. Everyone else buys a report and a suspended loss.
Contact your tax team today to model your property under current law. Prompt, dependable communication throughout the year.
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Disclaimer: This material is intended for educational and informational purposes only and does not constitute tax, legal, accounting, or financial advice. The content is general in nature and may not apply to your specific circumstances. Tax laws and financial regulations are subject to change and interpretation, and the application of these laws can vary based on individual situations. Before making any decisions, you should consult with a qualified tax advisor, legal counsel, or financial professional.
