Bonus Depreciation for Rental Property in 2026

#What the OBBBA changed for rental investors

For several years, bonus depreciation was on a glide path to zero. The Tax Cuts and Jobs Act of 2017 set it at 100% through 2022, then it stepped down: 80% in 2023, 60% in 2024, 40% in 2025. Many investors skipped cost segregation studies because partial bonus made the math less compelling.

The OBBBA reversed that permanently. Congress locked 100% bonus depreciation back into the tax code for any qualified property placed in service after January 19, 2025. There is no sunset. The IRS confirmed the new rules in Notice 2026-11.

For rental property, that means every 5-year, 7-year, and 15-year component a cost seg study pulls out of the 27.5-year building bucket can be fully expensed in year one. On a $500,000 rental, a study typically reclassifies $100,000 to $130,000 of basis into those faster categories. For the full breakdown of which components qualify, what a study costs, and the year-one deduction math, read our cost segregation fundamentals guide. You can also get the full OBBBA context in our guide to permanent bonus depreciation under the OBBBA.

The question this article answers is different: bonus depreciation creates the deduction. The passive loss rules determine whether you can use it.

#Why a $120,000 deduction might save you nothing in year one

Here is the question most investors skip until after the cost seg study is done: can I actually use this loss right now?

Under IRC §469, rental activities are passive by default. Passive losses can only offset passive income. Passive income comes from other rental properties, real estate syndication K-1 income, and a handful of other passive sources. It does not include W-2 wages, business income, or investment income like dividends and interest.

If you generate a $120,000 paper loss from cost seg and bonus depreciation but have no passive income to absorb it, the loss gets suspended by §469. It carries forward year after year. You do not lose it, but you cannot use it until one of three things happens: you generate passive income in a future year, you sell the property, or you break out of passive characterization entirely.

For a software engineer earning $400,000 in W-2 wages who buys a single rental, this is almost certainly what happens. The cost seg produces a paper loss. The paper loss parks on the books. The W-2 stays fully taxable.

That does not mean cost seg is the wrong move. Suspended losses release on sale, and the time value of money still matters. But you need to know what you are walking into before you write the check.

#The three paths through IRC §469

There are three real paths around the passive loss wall. Each has a different bar to clear.

#Path 1: The $25,000 active participation allowance

Under IRC §469(i), if you actively participate in your rental and your modified adjusted gross income is under $100,000, you can deduct up to $25,000 of rental losses against ordinary income each year.

Active participation is a low bar. Making management decisions — approving repairs, choosing tenants, setting rent — qualifies. You do not need to be physically involved daily.

The phase-out runs from $100,000 to $150,000 of MAGI. The allowance shrinks by $0.50 for every $1 of MAGI above $100,000. At $150,000, it reaches zero.

Quick math: a $120,000 MAGI investor with active participation can deduct $25,000 minus ($120,000 - $100,000) x 0.50 = $15,000 of rental losses against ordinary income. The remaining $105,455 stays suspended.

For most investors running a cost seg study, this path closes quickly. The people who need a $120,000 deduction the most tend to earn well above $150,000 of MAGI.

#Path 2: Real estate professional status under IRC §469(c)(7)

If you qualify as a real estate professional, your rental activities become non-passive entirely. That $120,000 deduction can offset your W-2 wages, your business income, or any other ordinary income directly.

Two statutory tests must both be met:

• More than 750 hours per year in real property trades or businesses in which you materially participate
• More than 50% of your total personal services time spent in those real estate activities

Then you must also materially participate in each rental property. If you own multiple rentals, a grouping election under Reg. §1.469-9(g) lets you treat all your rental real estate as one combined activity for material participation purposes. That is usually the move.

#Path 3: The short-term rental exception

If your rental averages 7 days or fewer per guest stay, it is not treated as a rental activity under IRC §469(c)(2). See the full STR loophole guide for the exact material-participation tests and documentation requirements. It becomes a business activity. With material participation in that business, the losses are non-passive and can offset your other income directly.

This path does not require 750 hours or the 50% test. You need material participation in the STR — typically by spending more than 100 hours in the activity and more than any other person who works in it, including your property manager.

The practical limits: STRs require more hands-on management than long-term rentals. You are more likely to meet material participation naturally. But if you hand everything to a manager and do not log meaningful hours, you may not qualify. And local zoning restrictions on STRs add operational risk.

Read our full breakdown in passive activity loss rules explained.

#REPS in practice: what the hours actually look like

Real estate professional status deserves a closer look because it is the highest-impact path and the most misunderstood. Getting it wrong means the losses stay suspended. Getting it right means $38,546 of immediate tax savings on a $500,000 rental in the 32% bracket.

The 750-hour test in practice. 750 hours over 12 months is roughly 63 hours per month, or about 15 hours per week. For an investor managing multiple properties with an involved style, this is reachable. For someone with one rental and a full-time property manager, it usually is not.

What counts toward 750 hours:

• Driving to properties and overseeing contractors
• Marketing vacant units and screening tenants
• Managing books and reviewing financial statements
• Negotiating leases and meeting with property managers
• Researching acquisitions (for properties in your real property trades)

What does not count: passive investing, attending real estate seminars, commuting to a day job.

The 50% test is the hard gate. Example: you work 2,000 hours at your day job and spend 900 hours on real estate. Your real estate percentage is 900 / 2,900 = 31%. You fail the 50% test even though you easily clear 750 hours. To pass, your real estate hours must exceed all other working hours combined.

Two worked examples:

Investor A left corporate work in 2025 and now manages 10 rentals. She logs 65 hours per month on real estate activities (780 hours per year) and does light consulting (180 hours per year). Real estate percentage: 780 / 960 = 81%. Hours: 780 exceeds 750. Both tests pass. With a grouping election covering all 10 rentals, she qualifies for REPS and the cost seg loss offsets her consulting income directly.

Investor B works a 40-hour week at a tech company (2,080 hours per year) and owns 3 rentals through a property manager. He personally logs 250 hours per year on real estate. Real estate percentage: 250 / 2,330 = 11%. Hours: 250 falls short of 750. Both tests fail. His path is the STR exception or the $25,000 allowance if his MAGI qualifies.

The spouse REPS rule. If only one spouse qualifies for REPS, both spouses benefit. The qualifying spouse’s material participation in the rentals applies to the jointly-filed return. This lets a household where one partner manages properties full-time and the other has a high-income W-2 job use the rental losses against that W-2 income. The qualifying spouse’s hours and participation determine REPS status; the household files jointly and takes the benefit.

#The recapture trade-off at exit

100% bonus depreciation is not free. When you sell, you pay tax on the depreciation you took. The rate depends on what type of property you depreciated.

Section 1245 recapture on 5-year and 7-year components. Personal property components you fully expensed are Section 1245 property. At sale, every dollar of depreciation you claimed on those components is recaptured as ordinary income. At a 32% bracket, $75,000 of Section 1245 recapture produces $24,000 of additional tax in the sale year.

Section 1250 recapture on the building. The 27.5-year building portion is Section 1250 property. Depreciation taken on it is treated as unrecaptured Section 1250 gain and taxed at a federal rate capped at 25%. For most investors in the 32% or 37% bracket, this is actually a lower rate than ordinary income. That is a favorable trade.

The time-value argument. Taking a 32-cent-per-dollar deduction today and paying 25 to 32 cents per dollar in recapture years later is almost always a net positive. Money kept now compounds. If you invest $38,546 of year-one tax savings at 8% per year, by year seven that grows to about $63,000. Even after recapture tax at sale, you came out ahead.

Three strategies to manage recapture:

1. 1031 exchange. Rolling sale proceeds into a like-kind replacement property defers all recapture and capital gain. The depreciation basis carries over, but the tax stays in the future indefinitely. Combine aggressive cost seg with a 1031 exit plan and you build real estate wealth without writing a check to the IRS at each sale.

2. Installment sale. Spreading proceeds over multiple years can spread the recapture income across tax years, potentially keeping you in lower brackets each year and reducing the bite.

3. Hold to death. Assets transferred at death receive a step-up in basis. Accumulated depreciation recapture disappears for the heir. Take the deductions for life, eliminate the recapture at death.

For the full recapture math and each planning strategy, see depreciation recapture on rental property sale.

#When electing out of bonus depreciation makes sense

Bonus depreciation is the default under the OBBBA. If you want straight-line instead, you make an explicit election out on Form 4562. Most investors should take the bonus. But there are four situations where electing out is the smarter call.

1. Your income is unusually low this year. If your taxable income puts you in the 12% or 22% bracket, each dollar of deduction saves 12 to 22 cents. In a future year at 32%, the same deduction saves 32 cents. Electing out and spreading depreciation over the recovery period means more of it lands in higher-bracket years. You give up the time value of money but gain better bracket alignment.

2. Your passive losses are already fully suspended. If you carry $300,000 of suspended passive losses from prior years and have no path to use them, adding more suspended losses through cost seg does not help you this year. The losses carry forward either way. Electing out does not change the near-term outcome and avoids piling recapture exposure at exit.

3. Your state does not conform to bonus depreciation. Many states decouple from the federal bonus rules. California does not allow bonus depreciation at all. Every dollar of federal bonus taken by a California investor adds back to state taxable income. On $120,000 of bonus deductions, a California investor in the 9.3% state bracket owes roughly $11,160 in additional state taxes. That erodes the federal savings significantly. Check your state’s conformity before assuming the full federal benefit flows through.

4. You plan to sell within one or two years. Accelerating depreciation and then selling quickly means recapture comes back fast with almost no time-value benefit. Straight-line may produce a cleaner result in short holds.

The election is asset-by-asset and class-by-class. You can elect out for the 5-year components while keeping the 15-year bonus. Make these decisions with the full picture of your bracket, your state’s rules, your exit timeline, and whether your losses will actually be usable.

#Common questions

Why can’t I just deduct rental losses against my W-2 income? Because IRC §469 classifies rental activities as passive by default. Passive losses can only offset passive income — not wages, not business income, not investment income. The only exceptions are the $25,000 active participation allowance (phases out above $100K of MAGI), real estate professional status, and the short-term rental exception.

What is the fastest path to using a cost seg loss against W-2 income? The short-term rental exception is usually faster to reach than REPS. If you already own or are buying a property that averages 7 days or fewer per stay, meeting material participation (typically 100+ hours, more than anyone else) is often achievable without the 750-hour and 50%-of-time tests that REPS requires. That said, if you have multiple long-term rentals, the REPS path through a grouping election may be better long-term.

Can my spouse qualify for REPS if I have a full-time job? Yes. If your spouse qualifies as a real estate professional (750+ hours in real property trades and more than 50% of their working time in real estate), your joint return can use the rental losses against your combined income. The qualifying spouse’s hours and participation satisfy the REPS tests for the household.

What happens to suspended passive losses when I sell? On a full disposition, all previously suspended passive losses become deductible in the year of sale. They offset the gain, the recapture income, or any other income that year. The suspension is temporary, not permanent. This is one reason a large suspended loss position is still valuable even if you cannot use it annually.

Is depreciation recapture taxed at my ordinary income rate? It depends on the property type. Section 1245 property (5-year and 7-year personal property components) is recaptured at your ordinary rate, which could be 32% or 37% for high-income investors. Section 1250 property (the building) is taxed at a maximum of 25% federal. So the building recapture is often taxed at a lower rate than the component recapture.

Do I have to take bonus depreciation, or can I choose straight-line? Bonus depreciation is the default under the OBBBA. You can elect out on Form 4562, asset class by asset class. See the section above on when electing out makes sense. Most investors in higher brackets with usable losses should take the bonus. Investors in low-bracket years, with fully suspended losses, or in non-conforming states should run the comparison first.

How does a 1031 exchange affect the recapture from bonus depreciation? A 1031 exchange defers all of it. Both the capital gain and the depreciation recapture are pushed into the replacement property’s basis and tax history. You do not owe recapture tax in the exchange year. The deferred recapture eventually comes due when you sell the replacement property without exchanging, but rolling from property to property keeps it deferred indefinitely.

What if I have passive income from other rentals — does it absorb the suspended loss? Yes. Passive income from any source in the passive activity category can absorb passive losses. If you have six rentals and five are profitable, the net passive income from those five offsets the cost seg loss from the sixth. As your rental portfolio grows and generates more net passive income, large bonus deductions become increasingly usable each year without needing REPS or STR status.

#Ready to run the numbers on your rental?

Every rental acquisition after January 19, 2025 deserves a cost seg conversation before you file. The opportunity is real, but the passive loss question determines whether you see that savings this year or in a future year. Book a 15-minute Tax Discovery — Google Meet, no pitch, free advice either way. We will tell you whether cost seg makes sense for your specific property, which §469 path fits your income picture, and what the exit looks like when you sell. We also work directly with qualified cost seg engineers so you get one integrated process, not two separate firms.

Learn more about our cost segregation service or explore what we do for real estate investors.