Your CPA mentions "168(k)" on every call. Your cost segregation report references "MACRS property classes." Tax articles cite Section 168 as if every investor already knows what it means.

Many real estate investors don't. That matters, because Section 168 sets the recovery periods, methods, and conventions that control how fast you recover your building's cost.

This guide explains Section 168 in plain language. You'll learn how MACRS property classes work and how bonus depreciation under 168(k) speeds up your deductions. You'll also see where cost segregation fits and where the rules limit the benefit.

What Is IRC Section 168?

IRC Section 168 creates the Modified Accelerated Cost Recovery System (MACRS). Section 167 allows the depreciation deduction. Section 168 tells you how to calculate it for most tangible property, including rental and commercial buildings (26 U.S.C. §168).

For each depreciable asset, Section 168 answers three questions:

• Recovery period: How many years you depreciate the asset.
• Method: How fast the deduction comes, such as straight-line or declining balance.
• Convention: When depreciation starts in the first year.

Buildings use the mid-month convention. A building placed in service in March gets 9.5 months of depreciation in year one. Most 5-, 7-, and 15-year property uses the half-year convention. The mid-quarter convention applies instead if more than 40% of the year's applicable depreciable basis is placed in service in the last quarter. The test excludes residential rental and nonresidential real property, so a fourth-quarter building purchase can trigger it through the short-life components reclassified by a study (IRS Publication 946).

Two related sections often come up in the same conversation. Section 179 lets a business expense certain property up to an annual cap. For 2026, the cap is $2,560,000, with a phase-out starting at $4,090,000 (Rev. Proc. 2025-32). Section 179 requires use in an actively conducted trade or business and is limited by taxable income from all of the taxpayer's actively conducted trades or businesses, including wages. Noncorporate lessors also face special restrictions under §179(d)(5). Section 168(k) provides bonus depreciation without Section 179's business-income cap. For most real estate investors, 168(k) has the bigger effect because it applies to the qualifying short-life components a study identifies.

MACRS Property Classes for Real Estate

MACRS groups depreciable property by recovery period. These classes come up most often in real estate.

5-Year Property

Appliances, carpets, and furniture used in residential rental property are 5-year property (IRS Publication 527). Electrical and plumbing connections that serve specific equipment can also qualify as personal property. Cabinetry and countertops may qualify, depending on how they are used and attached. These calls are fact-specific, so an engineer documents each item.

7-Year Property

Office furniture, fixtures, and equipment, such as desks and files, are 7-year property (Pub. 527). Property with no assigned class life also defaults to 7 years. This class shows up more often in offices and commercial buildings than in rentals.

15-Year Property

Land improvements are 15-year property. Examples include parking lots, roads, sidewalks, fences, and landscaping. The land itself is never depreciable. Our guide to asset recovery periods lists more examples.

Qualified improvement property (QIP) is also 15-year property under GDS, but it uses straight-line depreciation rather than declining balance. QIP covers interior improvements made by the taxpayer to a nonresidential building after the building was first placed in service. Existing interiors purchased with a building are generally part of the buyer's 39-year building, not the buyer's QIP, although a study can still identify separate 5- and 7-year components. Enlargements, elevators, escalators, and internal structural framework are excluded (26 U.S.C. §168(b)(3)(G) and (e)(6)).

27.5-Year Property

Residential rental property is a building where at least 80% of gross rental income comes from dwelling units. This includes apartment buildings, single-family rentals, and duplexes.

39-Year Property

Nonresidential real property includes commercial real estate such as office buildings, retail centers, and industrial properties. Hotels and motels also fall here when more than half of the units are used on a transient basis.

Example: $1.2M Residential Rental Property

Assumptions: The investor acquires and places the property in service in 2026, with no pre-January 20, 2025 binding acquisition contract. The reclassified assets qualify for 100% bonus depreciation, and the investor does not elect out. The investor is in the 37% federal bracket and can use the full deduction this year after applicable loss limits. Building depreciation is shown as a full-year amount. Year one will be lower under the mid-month convention.

• Purchase price: $1,200,000
• Land value (18%): $216,000
• Depreciable basis: $984,000

Without a study: $984,000 ÷ 27.5 = $35,782 per full year.

With a study (assuming 30% is reclassified; results vary by property):

• 5-year property (appliances, carpet, furniture, dedicated electrical): $177,120 (18%)
• 15-year property (paving, fencing, landscaping): $118,080 (12%)
• 27.5-year structure: $688,800 (70%)

Year-one deductions with 100% bonus depreciation:

This is a timing benefit. Future deductions are smaller, and recapture can apply when you sell.

How do I know which class my property falls into?

The building defaults to 27.5 or 39 years. A cost segregation engineer reviews each system, fixture, and site improvement. The final report assigns each asset to a MACRS class and documents the basis for that call.

Depreciation Methods: GDS and ADS

Section 168 also sets how you calculate each year's deduction. It provides two systems.

General Depreciation System (GDS)

GDS is the default system. It uses these methods:

• 5- and 7-year property: 200% declining balance, switching to straight-line when that gives a larger deduction.
• 15-year land improvements: 150% declining balance, switching to straight-line.
• 15-year QIP: Straight-line only, before any bonus depreciation.
• 27.5- and 39-year property: Straight-line only.

Short-life assets get larger deductions in the early years. That front-loading is why reclassification matters.

Alternative Depreciation System (ADS)

ADS uses straight-line depreciation over longer periods:

• Residential rental property: 30 years if placed in service after 2017; generally 40 years for earlier property. Qualifying pre-2018 residential rental property held by an electing real property trade or business uses 30 years instead (Rev. Proc. 2021-28).
• Nonresidential real property: 40 years
• Land improvements: 20 years
• QIP: 20 years

ADS is required for property used mainly outside the United States, tax-exempt use property, tax-exempt bond-financed property, and certain imported property. It also applies to property you elect to put on ADS (26 U.S.C. §168(g); IRS Publication 946).

The case that matters most for investors is the business interest election. A real estate business that elects out of the §163(j) interest limit must use ADS for its buildings and QIP. QIP subject to mandatory ADS loses bonus eligibility; the buildings already do not qualify under §168(k). The election does not move the separate 5- and 7-year components or 15-year land improvements to ADS. Those assets retain GDS and bonus eligibility if they otherwise qualify, so a study can still provide a substantial benefit (IRS §163(j) Q&A).

Should I use GDS or ADS?

GDS gives larger early deductions, so most investors use it. ADS mainly comes into play when a leveraged real estate business weighs the §163(j) election. That election is irrevocable. Model the interest savings against the lost depreciation with your CPA first.

Section 168(k): Bonus Depreciation

Section 168(k) lets you deduct a percentage of qualifying property's cost in the year you place it in service.

Current Rate

The One Big Beautiful Bill Act (Public Law 119-21) was signed July 4, 2025. It made 100% bonus depreciation permanent for qualified property acquired and placed in service after January 19, 2025 (IRS Notice 2026-11). Read our summary of the Big Beautiful Bill and the return of 100% bonus depreciation.

The acquisition date is generally the written binding-contract date when a qualifying contract exists, not the closing date. A binding contract must be enforceable under state law; a damages limitation below 5% of the purchase price generally prevents it from qualifying. Without a prior binding contract, the actual acquisition date generally controls. For self-constructed property, physical work of a significant nature generally marks the start of construction, with a 10%-of-cost safe harbor available. A binding contract signed in late 2024 can therefore leave a purchase that closes in 2026 under the old bonus schedule (26 CFR §1.168(k)-2(b)(5)).

Before the law changed, the rate was phasing down: 100% through 2022, 80% in 2023, and 60% in 2024. Property acquired before January 20, 2025 keeps the old schedule based on when it is placed in service: generally 40% in 2025, 20% in 2026, and 0% from 2027. Certain longer-production-period property and aircraft follow a schedule one year later. For your first tax year ending after January 19, 2025, you can also elect 40% instead of 100% for otherwise eligible property (60% for certain longer-production-period property and aircraft).

Qualifying Property

Bonus depreciation generally applies to MACRS property with a recovery period of 20 years or less, plus QIP, subject to statutory exclusions. For real estate, that means the 5-, 7-, and 15-year components and QIP a study identifies. The 27.5- and 39-year building structure does not qualify under 168(k).

A separate provision offers an elective deduction for manufacturers. New §168(n) allows a 100% deduction for qualified production property. That's the portion of a new nonresidential building used in manufacturing, production, or refining. Construction must begin after January 19, 2025, and before 2029. The property must be placed in service before 2031, and its original use must begin with you (IRS Notice 2026-16). The taxpayer generally must use the property itself as an integral part of a qualified production activity. A landlord leasing a building to a manufacturer generally cannot claim the deduction. Notice 2026-16 provides exceptions for leases within a consolidated group and for eligible individuals or pass-through lessors leasing to a commonly controlled business under its 50%-ownership rules. Office, administrative, parking, and research-and-development space is excluded. If qualifying production use ends within 10 years after the property is placed in service, the special deduction is generally subject to ordinary-income recapture. See how this applies to manufacturing facilities.

New and Used Property

For property acquired after September 27, 2017, used property can qualify, subject to the acquisition and prior-use rules. Generally, you must not have held a depreciable interest in the property during the applicable five-calendar-year lookback period, and you cannot buy it from a related party. Carryover-basis acquisitions and inherited property with a basis determined under §1014 are excluded. For qualifying used replacement property received in a 1031 exchange, only eligible excess basis—the additional investment, rather than the carried-over basis—can qualify for bonus depreciation (26 CFR §1.168(k)-2(b)(3)(iii) and (g)(5)(iii)).

Example: $2M Commercial Property

Assumptions: The property is acquired and placed in service in 2026, with no pre-January 20, 2025 binding acquisition contract. The reclassified assets qualify for 100% bonus depreciation, and the investor does not elect out. The investor is in the 37% bracket and can use the full deduction after applicable loss limits. Building depreciation is a full-year amount.

• Depreciable basis (85%): $1,700,000
• Reclassified to 5-, 7-, and 15-year property (35%): $595,000
• Remaining 39-year structure: $1,105,000

The study adds $579,743 in year-one deductions and $214,505 in year-one tax savings. Later deductions are smaller by the same amount, and recapture can apply at sale.

How Cost Segregation Applies Section 168

Section 168 defines the property classes. Cost segregation identifies which of your building's components belong in each class.

Without a study, most investors depreciate almost everything except land over 27.5 or 39 years. That includes items such as carpet and parking lots that qualify for shorter lives. A cost segregation study assigns those costs to the correct class with engineering support.

The IRS publishes a Cost Segregation Audit Techniques Guide (Publication 5653). It explains how examiners evaluate studies. It is not binding authority, but it shows the documentation examiners expect. Our IRS audit guide covers how to prepare.

Example: $3M Hotel

A hotel has many finishes, furnishings, and site improvements. Assume a $3M hotel acquired and placed in service in 2026, with no pre-January 20, 2025 binding acquisition contract, $2,550,000 of depreciable basis, a 37% bracket, and full-year building depreciation. The reclassified assets qualify for 100% bonus depreciation, the investor does not elect out, and the investor can use the full deduction after applicable loss limits.

• Reclassified (35%): $892,500
  • 5- and 7-year: furniture, fixtures, and equipment, decorative lighting, signs
  • 15-year: parking, landscaping, site lighting
• Remaining 39-year structure: $1,657,500

Look-Back Studies and Form 3115

If you've owned a property for years without a study, you can usually catch up without amending returns.

Once you've used a depreciation method on two or more filed returns, you have adopted it. Moving to the correct classification is then a change in accounting method under §446(e). You make the change on Form 3115 as an automatic change (DCN 7) under Rev. Proc. 2025-23. If you've filed only one return, you can amend it instead.

A look-back study produces a §481(a) adjustment. That's the difference between the depreciation you claimed and the depreciation you were allowed. A negative §481(a) adjustment is generally deducted entirely in the year of change (Rev. Proc. 2015-13, §7.03). The bonus rate follows the property's original acquisition and placed-in-service dates. Bonus can be included only if it was available for the asset and no election out was made for that class in the original placed-in-service year.

Example: $1M Property Placed in Service in March 2022

• Depreciable basis (82%): $820,000
• Reclassified to 5- and 15-year property (30%): $246,000
• Depreciation claimed on that $246,000 as 27.5-year property, 2022 to 2025: $33,916. That's 13.787% under Pub. 946 Table A-6 (2.879% + 3 × 3.636%).
• Depreciation allowed with 100% bonus for 2022, assuming eligibility and no election out for the applicable classes: $246,000
• §481(a) adjustment in 2026: $212,084
• Tax value at 37%: $78,471

The structure's own depreciation doesn't change. If the property had been placed in service in 2023, the bonus rate would have been 80%, and the catch-up would be smaller.

Can I change my depreciation on a property I've owned for years?

Yes, if you still own the property at the start of the year of change. There's no fixed look-back limit. Attach Form 3115 to your timely filed return, including extensions, for the year of change. Send a signed copy to the IRS as well.

Common Section 168 Questions from Investors and CPAs

Does 168(k) apply to land improvements?

Yes. 15-year land improvements, such as paving, fencing, and landscaping, qualify for bonus depreciation. The rate is 100% if you acquired and placed them in service after January 19, 2025, subject to the acquisition-date rules and other eligibility requirements.

What happens to the remaining basis after bonus depreciation?

Bonus depreciation reduces each asset's basis first. Any remaining basis follows regular MACRS. The building keeps depreciating on its 27.5- or 39-year schedule under standard depreciation rules.

Can I opt out of bonus depreciation?

Yes. You can elect out for an entire class, such as all 15-year property, in a given tax year. You can't revoke the election without IRS consent. Some investors opt out to save deductions for higher-income years.

How does recapture work?

Depreciation recapture depends on the asset:

• 5- and 7-year property: Section 1245 property. Gain up to the depreciation taken is ordinary income.
• 15-year land improvements: Section 1250 property. Depreciation above straight-line, including bonus, is recaptured as ordinary income (26 U.S.C. §1250).
• Buildings: Straight-line depreciation is taxed at up to 25% as unrecaptured §1250 gain (26 U.S.C. §1(h)).

A 1031 exchange can defer gain on qualifying real property. Since 2018, Section 1031 applies only to real property. Components treated as personal property are generally taxable, with their §1245 recapture recognized, unless they independently meet the real-property definition for exchange purposes (26 CFR §1.1031(a)-3). Section 1245(b)(4) matters only for §1245 components that qualify as real property under Section 1031; recapture may still be recognized if the replacement property does not include enough §1245 property (26 U.S.C. §1245).

Can I use these deductions against my W-2 income?

Often not. Rental losses are generally passive and offset only passive income. Whether you benefit this year depends first on basis and at-risk limits, then the passive loss rules, and finally, for non-passive business losses, the §461(l) excess business loss limit (IRS Publication 925).

• Active-participation allowance: Eligible landlords can deduct up to $25,000 of rental real estate losses against non-passive income. The allowance generally phases out between $100,000 and $150,000 of modified adjusted gross income. For married filing separately, it is halved, with a $50,000–$75,000 phase-out, if spouses lived apart all year; otherwise it is unavailable.
• Real estate professionals: Real estate professional status requires more than 750 hours and more than half of your personal services in real property trades or businesses in which you materially participate. On a joint return, one spouse must meet both tests individually. You must then also materially participate in the rentals. An optional election under Reg. §1.469-9(g) treats rental real estate interests as one activity for this purpose.
• Short-term rentals: The short-term rental route can avoid the default rental-activity treatment when the activity meets an exception, but material participation is still required for non-passive treatment.

For 2026, the §461(l) threshold is $256,000, or $512,000 on a joint return. This limit applies to a noncorporate taxpayer's net loss across all trades or businesses, after business income and gains offset business deductions—not to the depreciation deduction by itself. Losses already suspended under the passive rules do not reach this test. A disallowed excess business loss becomes a net operating loss carryforward (Rev. Proc. 2025-32; 26 U.S.C. §461(l)). The examples above assume the investor can use the full deduction; they do not establish that the same tax savings are available to every investor.

Unused passive losses generally carry forward. State rules can also differ, because some states don't follow federal bonus depreciation.

Key Takeaways

• Section 168 sets the recovery period, method, and convention for most rental and commercial property.
• The main real estate classes are 5-, 7-, and 15-year property (including QIP), 27.5-year residential rental property, and 39-year nonresidential property.
• 100% bonus depreciation applies to qualifying 5-, 7-, and 15-year property and QIP acquired and placed in service after January 19, 2025, subject to acquisition-date rules and other eligibility requirements (Notice 2026-11).
• Buildings don't qualify for 168(k). Separate §168(n) provides an elective deduction for qualifying production property, generally used by the taxpayer rather than leased to an unrelated manufacturer.
• Bonus depreciation shifts deductions into year one. On sale, bonus taken on land improvements is recaptured as ordinary income.
• Form 3115 lets you claim missed depreciation in one year without amending returns, if you still own the property.
• Basis, at-risk, passive loss, and excess business loss rules determine whether you can use the deduction now or must carry it forward.

See What Section 168 Means for Your Property

Your savings depend on your property's asset mix, your acquisition date, and your tax situation. Run your numbers with our depreciation calculator. Then get a free proposal from R.E. Cost Seg to see how much first-year depreciation your property could unlock.