The deductions aren’t free — they come out of basis and some get recaptured at ordinary rates on sale. Here’s the full trade, including California’s steep version of it.
By Foad Nabi, EA · Enrolled Agent · California · June 2026
Cost segregation accelerates your deductions — it does not create free money. The deductions you pull forward come out of your basis, which means when you sell, more of your gain is taxed, and some of it is taxed at higher “recapture” rates instead of capital gains rates. Anyone selling you a study without explaining recapture is showing you half the picture. Here is the full one, so you can decide whether the timing trade is worth it for you.
Every dollar of depreciation you claim reduces your adjusted basis in the property. Lower basis means larger gain on sale. That much is true of all depreciation, cost seg or not. What cost segregation changes is the character of part of that gain — and character determines the rate.
Section 1250 — the building. Real property depreciation is recaptured as “unrecaptured §1250 gain,” taxed at a federal maximum of 25% — higher than the long-term capital gains rate, but not ordinary rates. This applies whether or not you did a cost seg study.
Section 1245 — the reclassified personal property. Here’s the cost-seg-specific part. The components a study moves into 5-, 7-, and 15-year classes are treated as personal property, and their depreciation is recaptured under §1245 at ordinary income rates — up to 37% federally — to the extent of the depreciation taken. So cost segregation shifts some of your future gain from the 25% lane into the ordinary-rate lane.
Cost segregation gives you deductions now at your ordinary rate, and on sale recaptures some of them at your ordinary rate — so the win is the time value of money and the rate arbitrage, not a permanent escape from tax.
Three reasons the trade typically favors doing the study. First, time value: a deduction today is worth more than the recapture years from now, especially if you reinvest the tax savings. Second, you may never trigger it: if you hold the property until death, the basis steps up and the recapture evaporates for your heirs; if you do a 1031 exchange, you defer it into the next property. Third, rate timing: many owners take the deduction in high-income years and sell or exchange in lower-income years or under a step-up.
California does not have a separate capital gains rate. It taxes all gain — capital gain, §1250 recapture, §1245 recapture — as ordinary income, at rates up to 13.3%. So while the federal system gives you preferential 25% and capital-gains treatment on parts of the gain, California simply taxes the whole thing at your marginal rate. Combined with California’s non-conformity to bonus depreciation on the way in, the California timeline looks very different from the federal one: smaller, slower deductions up front, and full-rate tax on the back end. This is exactly why a California cost-seg decision has to be modeled across the full hold, not just year one.
Ask three questions. How long will I hold? (Longer favors the study.) What will my rate be at deduction versus at sale? (Deduct high, recapture low is ideal.) And what’s my exit — sale, 1031 exchange, or hold-until-step-up? (The last two minimize or erase recapture.) If you’re likely to flip the property in a couple of years at the same income level, cost segregation’s advantage narrows. If you’re holding, exchanging, or estate-planning, the recapture is a manageable cost against a large up-front benefit.
Foad is a federally licensed Enrolled Agent who writes about tax and bookkeeping for small businesses.