This article is for educational purposes only and is not legal or tax advice. Opportunity Zone, partnership, lease, and depreciation results depend on the documents and facts, so confirm the treatment with your tax advisor before drafting or closing a transaction.
For a real estate attorney structuring a qualified opportunity fund, leased-property treatment can be the cleanest way to solve a practical problem: the sponsor needs site control, the landowner will not sell, and the business plan still depends on accelerated depreciation from improvements. A cost segregation study belongs in that conversation before the lease and QOZB operating agreement are final, because cost segregation only helps the taxpayer that owns depreciable improvements for federal income tax purposes.
The niche is not a general Opportunity Zone summary. It is the use of the leased tangible property rules under IRC §1400Z-2 and Treas. Reg. §1.1400Z2(d)-2(c) to let a QOZB operate on leased land or leased space while separately depreciating tenant-owned or ground-lessee-owned improvements. Cost segregation then identifies the portions of those improvements that fall outside the building shell, and cost segregation can change partner cash-flow projections, loss-allocation language, and exit modeling.
That drafting issue is especially important after OBBBA 2025 made the Opportunity Zone program permanent under IRC §1400Z-2 and restored full bonus depreciation for qualified property acquired after January 19, 2025 under IRC §168(k) as amended by OBBBA 2025. For QOF counsel, the legal documents now need to fit a longer-running OZ market in which sponsors may combine lease structures, new construction, tenant improvements, and Opportunity Zone cost segregation as a single tax and finance package.
Why would a QOF attorney use leased-property rules instead of a purchase?
A QOF attorney may use leased-property rules when the economics favor control without acquisition, such as a ground lease for a hotel, multifamily project, industrial conversion, medical office buildout, or mixed-use site. Under Treas. Reg. §1.1400Z2(d)-2(c), leased tangible property can be qualified opportunity zone business property when the lease is entered into after December 31, 2017 under that regulation, substantially all use occurs in a qualified opportunity zone under IRC §1400Z-2(d), and the lease terms meet the regulation’s market-rate and related-party limits.
The drafting benefit is that leased property can qualify without the same original-use or substantial-improvement purchase framework that applies to acquired tangible property under IRC §1400Z-2(d)(2)(D). That does not mean depreciation disappears. It means the attorney must separate the leased asset from the improvements the QOZB or QOF actually owns, because the lessee generally depreciates its own leasehold improvements rather than the landlord’s retained building.
For example, a QOZB may lease a warehouse shell from a local owner and spend investor capital on electrical upgrades, interior buildout, specialty plumbing, process equipment, parking, lighting, and site work. If the QOZB owns those additions for federal income tax purposes, a cost segregation study can classify depreciable components under IRC §168. If the lease says the landlord owns the improvements from inception and the economics match that wording, the QOZB may have a weaker depreciation position even if the QOF raised the cash.
Draft the lease as a tax document, not just a real estate document: the party that bears cost, risk, use rights, removal rights, and residual economics is usually the party that needs the depreciation schedule.
ClickDrag Finance structuring note for OZ cost segregation planning
How should the lease describe improvements so cost segregation is usable?
The lease should state which improvements are owned by the lessee during the term, which improvements may be removed, which improvements must remain, and how any surrender payment is calculated. For cost segregation, those provisions help the depreciation team tie asset ownership to invoices, construction draws, architectural schedules, and placed-in-service dates.
In a ground lease, the QOZB may own the building and site improvements during the lease term, while the land remains nondepreciable because land is not depreciable under IRC §167 and IRC §168. In a space lease, the QOZB may own removable trade fixtures, specialty equipment, signage, data wiring, and certain interior improvements, while the landlord may retain the structural shell. Cost segregation should follow that legal and tax ownership split.
Attorneys should also coordinate the lease with the development agreement, construction contract, lender documents, and QOZB operating agreement. If a lender requires collateral language that treats all improvements as landlord property, but the depreciation model assumes QOZB ownership, the transaction team has a document conflict. If the landlord funds improvements through rent abatements or allowances, the tax treatment should be modeled before the QOF memorandum shows depreciation benefits to investors.
This is where a pre-construction cost segregation provider selection process helps counsel. The cost segregation team can give the attorney a document request list early, including lease drafts, construction budgets, pay applications, equipment schedules, and architectural plans, so the final study matches the ownership and capitalization story told by the legal documents.
How do leased-property rules change depreciation timing for cost segregation?
Leased-property qualification under IRC §1400Z-2 does not itself create depreciation; depreciation arises when the QOF or QOZB owns depreciable property and places it in service under IRC §167 and IRC §168. Cost segregation changes timing by identifying shorter-lived assets within the owned improvements, including property with recovery periods described in IRC §168 such as 5-year property, 7-year property, and 15-year land improvements under that section.
For qualified property acquired after January 19, 2025, IRC §168(k) as amended by OBBBA 2025 allows 100 percent bonus depreciation when the statutory acquisition, original-use or used-property, and placed-in-service requirements are met. For qualified property acquired before January 20, 2025, IRC §168(k) follows the TCJA phase-down schedule as modified before OBBBA 2025. That date distinction matters in lease deals because a QOZB may sign the lease in one taxable year, buy equipment in another taxable year, and place the improvements in service only after construction is complete.
A cost segregation study can also identify qualified improvement property, commonly called QIP, when improvements to the interior of nonresidential real property meet IRC §168(e)(6). QIP that meets the conditions of IRC §168(k), including the acquisition timing rule after January 19, 2025 for full bonus depreciation under OBBBA 2025, may produce immediate deductions. Exterior work, elevators, escalators, enlargements, and structural framework are outside the QIP definition under IRC §168(e)(6), so the attorney should not let an offering model treat all tenant improvements as bonus-eligible QIP.
Recapture should be modeled in the exit section. If investors sell QOF interests after the 10-year holding period in IRC §1400Z-2(c), the fair-market-value basis election under that section can eliminate gain on the QOF interest that otherwise reflects prior depreciation. If the exit is an asset sale by a QOF or QOZB after the 10-year holding period in IRC §1400Z-2(c), counsel should separately model ordinary-income character under IRC §1245 and IRC §1250 because the asset-sale rules and investor reporting can differ from a sale of QOF interests.
What should the QOF operating agreement say about depreciation allocations?
The operating agreement should say how depreciation, bonus depreciation, and any later recapture items are allocated among investors. A cost segregation study can create large early deductions, but a partner can use partnership losses only to the extent allowed by IRC §704(d). Partnership debt allocations may increase outside basis under IRC §752 when the liabilities are properly allocated, so the debt provisions and loss-allocation provisions should be drafted together.
For an attorney, this is not just tax boilerplate. If a QOF promises investors depreciation allocations in a private placement memorandum, but the agreement lacks a workable economic arrangement under partnership tax principles, the sponsor may have investor-relations problems even before tax reporting is considered. Counsel should align the waterfall, tax distributions, target capital-account language, minimum-gain provisions, and deficit-restoration choices with the expected cost segregation deductions.
Bonus depreciation also changes cash conversations. If IRC §168(k) as amended by OBBBA 2025 allows 100 percent bonus depreciation for qualified property acquired after January 19, 2025, investors may receive substantial paper losses before the project produces stabilized cash flow. The operating agreement should explain whether tax distributions are based on taxable income, book income, available cash, or another formula, because cost segregation can widen the gap between taxable income and distributable cash.
If the QOZB completes a cost segregation study after a building was placed in service in a prior taxable year, Rev. Proc. 2015-13 is the procedural anchor for an accounting-method change when the taxpayer uses Form 3115 to claim catch-up depreciation. Counsel should make sure acquisition files, draw files, and placed-in-service records survive manager turnover, because a late cost segregation implementation depends on records that show what was built, when it was placed in service, and who owned it.
Where do attorneys see mistakes in leased OZ cost segregation deals?
The first mistake is treating the leased building as if the QOZB owns it. If the QOZB is only a tenant in an existing building, cost segregation generally applies to tenant-owned improvements and tenant-owned personal property, not to the landlord’s retained shell. The attorney should ask who is the tax owner before any depreciation number is shown in investor materials.
The second mistake is ignoring related-party lease limits. Treas. Reg. §1.1400Z2(d)-2(c) contains special rules for related-party leases, and those rules can require careful drafting when the landowner, developer, QOF sponsor, or property manager has overlapping ownership. If the same family office or developer group controls both sides of the lease, counsel should address market rent, prepayment limits, and improvement obligations in the same sentence of the transaction checklist under Treas. Reg. §1.1400Z2(d)-2(c).
The third mistake is using one global construction budget for both landlord work and QOZB work. Cost segregation needs a clean cost trail. A better approach is to create schedules for landlord-funded shell work, QOZB-funded tenant improvements, QOZB-owned equipment, land improvements, soft costs, and nondepreciable land or lease acquisition costs.
The fourth mistake is failing to connect the lease term with asset lives. If a QOZB installs property that is expected to be removed or abandoned before the lease ends, counsel should ask how removal rights, restoration duties, and abandonment reporting will work. If the improvements revert to the landlord without compensation, the economics may affect capitalization, depreciation assumptions, and investor disclosure.
What diligence checklist should counsel use before closing?
Before closing a leased-property OZ deal, counsel should run a checklist that combines IRC §1400Z-2 qualification and IRC §168 depreciation support. The checklist should confirm lease execution date, OZ location, market-rate rent support, related-party status, improvement ownership, capital expenditure responsibility, placed-in-service tracking, and exit mechanics.
- Confirm the OZ status. Use an address-level review and keep the file tied to the census tract, and counsel can start with ClickDrag’s Opportunity Zone qualifier for a location screen.
- Separate leased assets from owned assets. The QOZB can use leased property for IRC §1400Z-2 purposes, but cost segregation applies to depreciable property the QOZB or QOF owns for federal income tax purposes.
- Draft improvement schedules. Attach exhibits that identify landlord work, tenant work, removable trade fixtures, QOZB-owned equipment, and site improvements.
- Coordinate acquisition dates. IRC §168(k) as amended by OBBBA 2025 provides 100 percent bonus depreciation for qualified property acquired after January 19, 2025, so purchase orders and construction contracts should be organized by acquisition and placed-in-service timing.
- Model investor limitations. IRC §704(d) can limit loss use, and IRC §752 can affect partner outside basis when partnership liabilities are allocated.
- Write the exit paragraph carefully. IRC §1400Z-2(c), IRC §1245, and IRC §1250 should all be considered when the business plan assumes a sale after the statutory holding period.
The practical takeaway for real estate attorneys is simple: a lease can solve the OZ acquisition problem, but it does not automatically solve the depreciation problem. Cost segregation works best when the lease, capitalization records, and partnership agreement all point to the same taxpayer, the same assets, and the same placed-in-service dates.
Frequently Asked Questions
Can a QOZB use cost segregation on leased property?
Yes, a QOZB can use cost segregation on improvements and tangible property it owns for federal income tax purposes. The leased building itself is generally depreciated by the landlord, while tenant-owned improvements, equipment, and land improvements may be classified under IRC §168.
Does leased-property OZ treatment create depreciation by itself?
No, leased-property treatment under IRC §1400Z-2 and Treas. Reg. §1.1400Z2(d)-2(c) does not create depreciation by itself. Depreciation requires ownership of depreciable property under IRC §167 and IRC §168, so the lease must match the depreciation model.
Can cost segregation create bonus depreciation in an OZ lease structure?
Yes, cost segregation can identify property eligible for bonus depreciation when that property meets IRC §168(k) as amended by OBBBA 2025. For qualified property acquired after January 19, 2025, IRC §168(k) as amended by OBBBA 2025 allows 100 percent bonus depreciation when the other statutory requirements are met.
Does the 10-year OZ election eliminate depreciation recapture?
It can reduce or eliminate gain on a QOF interest sale after the 10-year holding period under IRC §1400Z-2(c). For an asset sale by a QOF or QOZB after the 10-year holding period under IRC §1400Z-2(c), counsel should separately model IRC §1245 and IRC §1250 character because reporting can differ from a sale of QOF interests.
Should the attorney order cost segregation before the lease is signed?
Usually, the attorney should involve the cost segregation team before the lease is signed when depreciation is material to investor returns. Early review can align improvement ownership, construction budgets, placed-in-service records, and QOF operating-agreement provisions before the documents lock in the economics.
