Most real estate investors know that a Section 1031 exchange may defer tax on the gain from a property they sell. Fewer realize that the replacement investment may create a second planning opportunity: accelerated depreciation. In the right situation, an investor may be able to defer gain on the old property while accelerating deductions on qualifying components of the new property. But the largest deduction is not necessarily the best strategy. The real objective is to match the investment and the depreciation strategy to the investor’s own tax situation.
That distinction is especially important today. Under current federal law, 100% bonus depreciation is available for certain qualified property acquired after January 19, 2025. For real estate investors, a properly prepared cost segregation study may identify shorter-lived assets that are potentially eligible for this accelerated treatment. The building itself generally is not bonus-depreciation property.
The strategy can apply to investors who buy replacement real estate directly, and it can also be relevant to investors who use qualifying Delaware Statutory Trust (DST) interests as replacement property in a 1031 exchange. The implementation, however, is different - and that is where careful planning becomes important.
A Section 1031 exchange and bonus depreciation are sometimes discussed as if they are competing tax techniques. They are not. They address different parts of the transaction.
Section 1031 generally allows qualifying gain to be deferred when business or investment real property is exchanged for qualifying like-kind real property.
Bonus depreciation accelerates the deduction of certain qualifying depreciable assets rather than spreading those deductions over several years.
A simple way to remember it: The 1031 exchange is primarily about what happens when you SELL. Cost segregation and bonus depreciation are primarily about how qualifying components of what you BUY may be depreciated.
A building is not one single asset for federal depreciation purposes. A cost segregation study examines the property and may identify components that have shorter recovery periods than the building itself. Depending on the property and the facts, qualifying items can include certain electrical systems, finishes, equipment, landscaping, parking improvements, site lighting and other assets.
The IRS recognizes cost segregation as a depreciation methodology and publishes an Audit Techniques Guide for evaluating these studies. When shorter-lived assets meet the applicable requirements, they may be eligible for accelerated depreciation, including 100% bonus depreciation under current law.
Example A: Directly Owned Replacement Property
Illustration - not a tax projection
Assume an investor completes a 1031 exchange into a larger rental property. After applying the 1031 basis rules, a qualified cost segregation study and the investor’s tax advisor determine that $150,000 of basis is eligible for 100% bonus depreciation. That could create a $150,000 first-year deduction. If the investor could fully use the deduction and were in a hypothetical 35% federal marginal bracket, the federal tax effect could be roughly $52,500. The actual result could be very different because basis, passive-loss rules, at-risk rules, state taxation and the investor’s other income all matter.
The point is not the $52,500 number. The point is that a 1031 exchange may defer gain and a separate depreciation analysis may create current deductions. Those are two different calculations that can coexist in the same transaction.
A properly structured DST may qualify as replacement real property for Section 1031 purposes under the facts and limitations described in IRS Revenue Ruling 2004-86. DSTs are therefore frequently considered by investors who want fractional ownership of institutional-style real estate without taking on direct day-to-day property management.
Cost segregation can be relevant here as well. Many DST sponsors - but not all - commission or provide cost segregation studies or related depreciation allocations for their offerings. Practices vary by sponsor, property type and offering. When a study is used, the sponsor’s tax-reporting package may reflect the resulting depreciation allocations, but each investor’s personal tax consequences still depend on that investor’s basis and individual tax circumstances.
Example B: Two DSTs With Similar Cash Flow - But Different Tax Profiles
The investment decision should not stop at the distribution rate
Suppose an investor has $500,000 of exchange equity and is comparing two DSTs with similar projected cash distributions. DST A owns a recently acquired property for which the sponsor has obtained a detailed cost segregation study and projects significant first-year depreciation. DST B owns a property with a different basis history and less accelerated depreciation. For an investor who has substantial passive income to offset, DST A’s depreciation profile could be valuable. For another investor who already has large suspended passive losses, the extra first-year deduction may provide little immediate benefit. The “better” DST therefore cannot be determined from depreciation alone.
This is why a headline such as “80% first-year depreciation” or “100% bonus depreciation available” should never be the end of the analysis. The question is how much depreciation is attributable to this particular investor, whether the investor can use it, and what the long-term consequences may be.
One of the most important concepts in this area is basis. In a qualifying 1031 exchange, the tax basis from the relinquished property generally carries into the replacement property, subject to adjustments. If the investor contributes additional consideration to acquire a larger replacement property, that may create additional or “excess” basis.
The depreciation rules can treat carryover basis and excess basis differently, particularly when determining eligibility for bonus depreciation in property acquired through an exchange. This is one reason an investor should not simply take the purchase price of the replacement property, multiply it by a cost-segregation percentage, and assume the result is immediately deductible.
Important: The exchange value, purchase price, depreciable basis, cost-segregation allocation and amount an individual investor can actually deduct are not necessarily the same number.
Accelerated depreciation can be extremely useful, but it is not automatically the right objective for every investor. Some investors may already have substantial suspended passive losses. Others may have relatively little passive income against which additional losses can currently be used. Some may expect their tax circumstances to change in future years. And accelerated deductions generally reduce basis, which may affect the tax consequences when the investment is ultimately sold.
Federal passive-activity and at-risk rules may also limit when a depreciation-generated loss can be used. A deduction that cannot be used currently may be suspended and carried forward rather than producing an immediate tax benefit.
The better question: Do not ask only: “Which property gives me the most depreciation?” Ask: “Given my current income, existing passive losses, tax bracket, exchange basis and long-term goals, how much accelerated depreciation would actually help me?”
The most useful time to consider these issues is before the replacement investment is finalized. An investor’s CPA or other personal tax advisor can estimate whether accelerated depreciation is likely to be useful and can help evaluate basis, passive-loss limitations and potential future recapture consequences.
At the same time, experienced 1031 and DST professionals can help compare the available replacement-property choices: property type, sponsor, leverage, targeted cash flow, lease structure, market, potential appreciation, hold-period assumptions and the availability of cost-segregation information.
What is my estimated tax basis in the replacement investment after the 1031 exchange?
Does the property or DST offering have a cost segregation study, and who prepared it?
How much depreciation is actually expected to be allocable to me?
Can I use the anticipated depreciation now, or is some of it likely to be suspended?
How does the tax profile compare with the investment’s targeted cash flow, debt, risk and appreciation potential?
A Section 1031 exchange may defer gain. Cost segregation may identify qualifying shorter-lived assets. Current law may allow 100% bonus depreciation for qualifying property. DSTs may offer access to these same general concepts, and many sponsors provide cost segregation information - but not every sponsor or offering does.
The opportunity can be significant, but accelerated depreciation is not needed by every investor and should never be evaluated in isolation. Before selecting replacement property, investors should work closely with their own CPA or other tax professional and with experienced FGG professionals to determine which investment and tax strategy best fits their individual objectives.
A practical objective: The goal is not to maximize a single tax deduction. The goal is to select a sound replacement investment and coordinate the 1031 exchange, depreciation strategy and long-term investment plan in a way that makes sense for the individual investor.
For further information on 1031 replacement-property strategies, DSTs and our comparison process, contact the professionals at First Guardian Group / FGG1031. Download our ebook to learn more by clicking the image below:
Important Tax and Investment Disclosure
This material is for educational and informational purposes only and is not intended as tax, legal or accounting advice, nor as an offer or recommendation to purchase any security. Tax results vary based on individual circumstances and applicable federal and state law. Investors should consult their own qualified tax and legal advisors before making tax or investment decisions. DST interests are securities and involve investment risk, including possible loss of principal, lack of liquidity, sponsor risk, real estate market risk and limitations on investor control. Tax laws and interpretations may change.
Selected IRS References
• IRS, Treasury and IRS guidance on the additional first-year depreciation deduction (Jan. 14, 2026) - permanent 100% bonus depreciation for qualifying property acquired after Jan. 19, 2025 under current law.
• IRS, Like-Kind Exchanges - Real Estate Tax Tips (updated May 1, 2026).
• IRS Publication 946, How To Depreciate Property (2025 revision), including special depreciation allowance and like-kind exchange basis guidance.
• IRS Publication 925, Passive Activity and At-Risk Rules (2025 revision).
• IRS Revenue Ruling 2004-86, Delaware Statutory Trust classification and Section 1031 treatment under the facts described in the ruling.
• IRS Cost Segregation Audit Techniques Guide (2025 publication).