Cost segregation raises the after-tax return on an Opportunity Zone investment most when the investor holds a qualifying investment in a Qualified Opportunity Fund for 10 years and makes the IRC §1400Z-2(c) election: in the worked example below, which assumes the year-1 depreciation is usable in the year it arises, a cost segregation study lifts the investor's after-tax IRR from 12.1% to 13.8% on a 10-year hold with the election, and from 10.3% to 11.4% on a sale in year 7, where recapture takes back more in dollars than the deduction saved and the IRR rises on timing alone.
The example is one hypothetical $10,000,000 multifamily project held in a fund taxed as a partnership, run four ways: with and without cost segregation, and sold either after the 10-year hold with the election or in year 7. Every figure on this page is computed from the assumptions in the next section, so you can change one and see what moves. For the mechanics behind it, see our Opportunity Zone cost segregation page.
What does the worked example assume?
- Project: $10,000,000 of purchase price plus construction cost, with land at 15% (our estimate engine's land share for multifamily), leaving $8,500,000 of depreciable basis.
- Cost segregation: 20% of the depreciable basis (purchase price plus construction costs, less land) reclassified, the low end of our published multifamily planning band of 20–30%; the rest is 27.5-year residential rental property, depreciated straight-line.
- Bonus depreciation: 100% on the reclassified property in year 1, which assumes the project counts as acquired after January 19, 2025. Bonus depreciation under IRC §168(k) is 100%, permanently, for qualified property acquired after January 19, 2025 (OBBBA, 2025-07-04), or, for self-constructed property, whose construction began after that date; qualified property acquired on or before that date stays on the TCJA phase-down (as does self-constructed property begun on or before it) by placed-in-service year: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% after that, with each rate one year later for long-production-period property and certain aircraft (§168(k)(6)(B)). The fund in this example builds its project, so the rule for self-constructed property sets that date: Self-constructed property, including property built for the taxpayer under a written binding contract entered into before construction began, is acquired when physical work of a significant nature begins; paying or incurring more than 10 percent of the total cost (excluding land and preliminary activities) is a safe harbor.
- Simplifications: every reclassified dollar is treated as 5-year §1245 property (a 15-year land improvement is §1250 property, so this overstates recapture on an early sale), depreciation runs in full years with no mid-month convention, and state tax and the net investment income tax under §1411 are left out.
- Financing: a loan of 60% of cost at 6.5%, interest-only, repaid at sale; the investor's equity is $4,000,000.
- Operations: net operating income of 6.0% of cost in year 1, growing 3% a year, and a property value that grows 3% a year.
- Tax rates: an assumed 37% federal ordinary rate, 25% on unrecaptured §1250 gain and 20% on the rest of the gain, for a noncorporate taxpayer.
- Usable losses: the year-1 loss is assumed usable in the year it arises. A Qualified Opportunity Fund interest funded with deferred gain starts at a $0 basis under IRC §1400Z-2(b)(2)(B), and partnership losses are deductible only up to basis under §704(d); a partner's share of partnership debt counts as basis under §752, so the accelerated depreciation is usually still usable. Whether it is usable depends on the investor's capital account and debt basis. The loss also needs at-risk amount under §465 and a route through the §469 passive activity rules.
- Left out on purpose: the capital gain the investor deferred into the fund. It is recognized on its own schedule whichever way the building is depreciated, so it does not change the comparison.
How does the 10-year election change what cost segregation is worth in an Opportunity Zone?
On a qualifying investment held 10 years, an investor who elected deferral and sells the interest in a Qualified Opportunity Fund taxed as a partnership may elect to step basis to fair market value under IRC §1400Z-2(c), and on that sale the election removes both the ordinary recapture and the unrecaptured §1250 gain, which is what converts cost segregation from a timing benefit into a permanent one.
In the example, cost segregation takes $4,172,727 of depreciation over the 10 years against $3,090,909 without a study, nearly all of the difference in year 1, and with the election none of it comes back at sale. The investor's after-tax profit rises from $6,459,147 to $6,859,419 and the after-tax IRR from 12.1% to 13.8%, a gain of 1.6 percentage points.
What happens to the cost segregation benefit on a sale in year 7?
On a taxable sale before year 10, recapture behaves normally: §1245 recapture on the 5- and 7-year property is ordinary income, as is §1250 recapture of the depreciation taken above straight-line (bonus included) on 15-year land improvements held more than one year, and the rest of the depreciation on those land improvements and on the 27.5- or 39-year structure is unrecaptured §1250 gain, taxed at up to 25% for a noncorporate taxpayer. Nothing about Opportunity Zone status shields that.
On the year-7 sale with cost segregation, the gain is $5,729,648: $1,700,000 is §1245 recapture taxed as ordinary income, $1,730,909 is unrecaptured §1250 gain and $2,298,739 is capital gain, for $1,521,475 of federal tax at sale, against $1,000,657 without a study. The after-tax IRR still rises, from 10.3% to 11.4%, because the deduction arrives in year 1 and the tax on it in year 7. The after-tax profit, though, falls from $3,275,138 to $3,223,211: the reclassified depreciation was deducted at 37% and recaptured at 37%, while the straight-line depreciation it replaced would have been taxed at no more than 25% at sale.
So before year 10 the benefit is one of timing, and whether it nets positive depends on the rates at which the deductions were used and the rates at sale; it becomes permanent only if you reach year 10 with the election. Model both cases before you accelerate.
How do the four cases compare?
| Case | Depreciation taken | Federal tax at sale | After-tax profit | After-tax IRR |
|---|---|---|---|---|
| 10-year hold with the election, no study | $3,090,909 | $0 | $6,459,147 | 12.1% |
| 10-year hold with the election, cost segregation | $4,172,727 | $0 | $6,859,419 | 13.8% |
| Sale in year 7, no study | $2,163,636 | $1,000,657 | $3,275,138 | 10.3% |
| Sale in year 7, cost segregation | $3,430,909 | $1,521,475 | $3,223,211 | 11.4% |
After-tax profit is the sum of the investor's after-tax cash flows less the equity invested. The table is an illustration of the mechanics, not a forecast for any property.
Does it matter whether the investor sells the interest or the fund sells the building?
Yes. The example models a sale of the fund interest. If the fund sells the property, a separate election under Treas. Reg. §1.1400Z2(c)-1(b)(2)(ii) can exclude the gain for partnership or S-corporation funds, and a corporate fund gets no such election. Which transaction a fund expects at exit belongs in the model before the cost segregation study is ordered.
To see whether a study fits your property, start with the qualifier. For what the reclassification looks like on an apartment building, see our multifamily cost segregation page. Before you engage a provider, what to ask a cost segregation provider on an Opportunity Zone deal lists the questions that decide whether its study supports both exits modelled here.
Related reading: Recapture Series · Part 1 — The Three Layers of Gain When You Sell, Recapture Series · Part 2 — Allocating the Sale Across Land, Shell, and Short-Life Assets and Recapture Series · Part 3 — Partial Dispositions: Writing Off the Old Without Double-Counting.
Frequently Asked Questions
Does cost segregation increase the after-tax IRR of an Opportunity Zone investment?
In this worked example it does in both exit cases: from 12.1% to 13.8% on a 10-year hold with the IRC §1400Z-2(c) election, and from 10.3% to 11.4% on a sale in year 7, assuming the year-1 depreciation is usable when it arises; on the year-7 sale the after-tax profit is lower with cost segregation, because the recapture is taxed at a higher rate than the straight-line depreciation it replaced.
Does the §1400Z-2(c) election remove depreciation recapture from cost segregation?
On a qualifying investment held 10 years, an investor who elected deferral and sells the interest in a Qualified Opportunity Fund taxed as a partnership may elect to step basis to fair market value under IRC §1400Z-2(c), and on that sale the election removes both the ordinary recapture and the unrecaptured §1250 gain, which is what converts cost segregation from a timing benefit into a permanent one.
What happens to cost segregation deductions if an Opportunity Zone investment is sold before year 10?
On a taxable sale before year 10, recapture behaves normally: §1245 recapture on the 5- and 7-year property is ordinary income, as is §1250 recapture of the depreciation taken above straight-line (bonus included) on 15-year land improvements held more than one year, and the rest of the depreciation on those land improvements and on the 27.5- or 39-year structure is unrecaptured §1250 gain, taxed at up to 25% for a noncorporate taxpayer. Nothing about Opportunity Zone status shields that.
Can a QOF investor with a zero basis use cost segregation depreciation?
A Qualified Opportunity Fund interest funded with deferred gain starts at a $0 basis under IRC §1400Z-2(b)(2)(B), and partnership losses are deductible only up to basis under §704(d); a partner's share of partnership debt counts as basis under §752, so the accelerated depreciation is usually still usable. Whether it is usable depends on the investor's capital account and debt basis.
Is 100% bonus depreciation available on Opportunity Zone property?
Bonus depreciation under IRC §168(k) is 100%, permanently, for qualified property acquired after January 19, 2025 (OBBBA, 2025-07-04), or, for self-constructed property, whose construction began after that date; qualified property acquired on or before that date stays on the TCJA phase-down (as does self-constructed property begun on or before it) by placed-in-service year: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% after that, with each rate one year later for long-production-period property and certain aircraft (§168(k)(6)(B)). Self-constructed property, including property built for the taxpayer under a written binding contract entered into before construction began, is acquired when physical work of a significant nature begins; paying or incurring more than 10 percent of the total cost (excluding land and preliminary activities) is a safe harbor. Qualifying as Qualified Opportunity Zone business property is a separate test under §1400Z-2, and it does not change how the property is depreciated once it qualifies.