How Real Estate Professional Status Supercharges a Cost Segregation Study
Most landlords know that a cost segregation study can front-load years of depreciation into the first year of ownership. Fewer realize that pairing cost seg with Real Estate Professional Status (REPS) can unlock those paper losses immediately—wiping out W-2 wages, business profits, even portfolio gains. Below is a plain-English roadmap, now more lucrative thanks to the reinstated 100 % bonus depreciation for assets placed in service after January 19 2025.
1. Cost Segregation in One Minute
An engineering-based report reclassifies components of a property from 27.5- or 39-year lives to 5, 7 or 15 years. The shorter lives qualify for first-year bonus depreciation—now back at 100 % through 2029—creating a large deduction in the year the study is placed in service. For background on carving out land value before the study, see our guide on using land value to maximize your cost segregation study.
2. Why Cost Seg Alone Rarely Offsets Your Day Job
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Depreciation from rentals is passive by default.
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Passive losses can offset only passive income.
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The special $25 k allowance phases out completely once AGI tops $150 k.
Result: high-earning investors often “warehouse” losses for years.
3. Enter Real Estate Professional Status (REPS)
Under IRC §469(c)(7) you convert rental activity from passive to non-passive by meeting two tests in a tax year:
| Test | Threshold | Practical Tip |
|---|---|---|
| 50 % Test | More than half of all personal-service hours are in real-property trades | Track every hour—bookkeeping counts, pure investing doesn’t |
| 750-Hour Test | At least 750 hours in those same trades | One spouse only; hours don’t stack |
You must also materially participate in the rental operations (500-hour safe harbor or aggregation election) to keep the activity non-passive.
4. REPS + Cost Seg: The Tax Math
Scenario
Purchase price: $1.0 M (land $200 k)
Cost seg identifies: $240 k of 5/7/15-year assets
Bonus depreciation: 100 % (placed in service 2025)
| Status | Year-1 Tax Result |
|---|---|
| Not REPS | $240 k passive loss → trapped unless you have passive income |
| REPS | $240 k non-passive loss → offsets spouse’s $240 k W-2 → $57,600 federal tax saved (24 % bracket) |
If total losses exceed ordinary income, the surplus can generate a refund.
5. Five Ways to Hit 750 Hours Ethically
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Project-manage renovations (site visits, contractor calls).
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Weekly “CEO hour”—rent rolls, KPIs, bookkeeping.
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Tenant lifecycle tasks—showings, screenings, lease signings, turnovers.
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Travel time between properties and suppliers (log mileage and time).
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Continuing-ed that drives decisions (webinars, code-compliance classes).
Use a cloud tracker plus a shared spreadsheet; courts toss after-the-fact estimates.
6. Common Pitfalls to Avoid
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Third-party managers. Outsourcing can drop your personal hours below 750; consider a hybrid model.
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No contemporaneous log. Re-created diaries rarely survive IRS scrutiny.
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Recapture shock. Accelerated depreciation is taxed at up to 25 % on sale; plan a 1031 exchange or cost-seg “look-back” study to defer.
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Bonus-depreciation timing. 100 % applies only to property placed in service after January 19 2025; earlier assets follow the stepped phase-down.
7. Frequently Asked Questions
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Does bonus depreciation still phase down? Assets placed in service after January 19 2025 qualify for 100 % through 2029; earlier assets follow the 60 % → 40 % schedule.
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Can I group all rentals for material participation? Yes—file the once-in-a-lifetime aggregation election under Reg. §1.469-9(g).
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Do both spouses need 750 hours? No; only the spouse claiming REPS must satisfy both tests.
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Will a cost seg study trigger an audit? Not by itself, but poor hour logs will. Keep the engineer’s report and time sheets.
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What if I exceed the loss needed? Extra non-passive loss can offset capital gains or business income; unused amounts carry forward.
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Can short-term rentals bypass REPS? Yes—if average stays are ≤ 7 days and you materially participate 100 hours, with more hours than anyone else.
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How much does a cost seg study cost? $5k–$15k is typical; ROI is highest on properties above $500 k.
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Does REPS eliminate self-employment tax? Rental income remains exempt from SE tax unless you provide hotel-type services.
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Can I retroactively claim REPS? Only by amending returns with solid contemporaneous logs—difficult to win.
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What happens on sale? Accelerated depreciation is recaptured at up to 25 %; plan a 1031 or installment sale.
