How to Depreciate Renovation Costs and Save on Taxes Under the OBBBA

The commercial real estate market has not been kind to investors in recent years. Vacancies, high interest rates, and escalating costs for building materials and contractors have driven profits down. Thankfully, recent changes in the Internal Revenue Service (IRS) tax code can help improve those margins. This article explains what that means. Some key takeaways:

1. 100% bonus depreciation was permanently restored with the passage of the One Big Beautiful Bill Act (OBBBA) on July 4th, 2025.
2. The Section 179 immediate expensing limit increased to $2.5M (from $1.25M), with a phase-out beginning at $4M.
3. Depreciation, amortization, and depletion no longer count against business interest deduction limits.

The OBBBA was signed into law on July 4, 2025, significantly changing the depreciation landscape. If you’re planning renovations or have recently completed them, these new rules will impact your business. Please contact me if you need help with that.

Let’s recap: How does depreciation work?

Experienced business owners should be familiar with depreciation. It appears as an expense on income statements and as accumulated depreciation on balance sheets. If you’re a new business owner, think of depreciation as a forecasting tool that spreads expenses across the years when you can benefit from them.

In other words, the Internal Revenue Service (IRS) allows you to allocate the cost of a physical asset over the course of its useful life. As the value of an asset decreases due to depreciation, the amount of taxes you pay goes down via depreciation-related tax deductions.

Renovation costs can also be depreciated because they can increase the property value.

Tax-neutral doesn’t mean zero taxes. It means using depreciation strategically to offset the cash you spent on renovations, minimizing the net impact on your bottom line.

Depreciation schedules break up the costs of capital expenses. The OBBBA brings back another option: 100% bonus depreciation, which was originally approved in 2017 as a temporary depreciation rule to help small business owners. As of July 4, 2025, it’s permanent. That means you may be able to deduct the full cost of property renovations in the tax year you pay for them.

The OBBBA fundamentally rewrites the depreciation playbook.

President Trump signed the OBBBA on July 4, 2025, and its provisions have changed depreciation strategies for the foreseeable future. Here’s what changed:

• 100% Bonus Depreciation Permanently Restored: For property acquired and placed in service after January 19, 2025, you can immediately deduct 100% of qualifying assets; this applies to property with a recovery period of 20 years or less.
• Section 179 Limits Increased: The immediate expensing limit increased to $2.5M (from $1.25M), with a phase-out starting at $4M (as previously stated).
• Qualified Production Property Gets 100% Deduction: Manufacturing and production facilities can now get an immediate 100% deduction if construction begins between 2025 and 2029 and the property is placed in service before 2031.
• Business Interest Deduction Expanded: Depreciation, amortization, and depletion will not affect business interest deduction limits.

With these new rules, cost segregation studies are now significantly more valuable. Components that previously depreciated over 27.5 or 39 years can now be fully deducted in year one if properly identified and classified. That’s a big deal if you’re renovating.

Remember that passive investment properties are treated differently from owner-operated buildings.

There are differences between passive investment properties and buildings where you’re actively involved in operations. The rules for passive investments are explained in IRS Publication 925. Pure investment properties are those where you collect rent checks and hire a property management company to handle everything else.

Owner-operated properties are another story. Examples include warehouses, storefronts, or offices where the owner is directly involved in maintenance and upkeep. The IRS views these differently from passive investments. Under the new OBBBA rules, owner-operated properties may have additional opportunities for immediate expensing under Section 179.

Different rules apply, depending on the building type.

Commercial property with tenants operates under different guidelines than owner-occupied spaces. If you own an office building and lease it to multiple tenants, the building structure depreciates over 39 years. Aside from that, the OBBBA allows you to fully deduct components identified through cost segregation, such as lighting, flooring, and specialized HVAC.

Office, warehouse, or storefront properties from which you conduct business have additional considerations. 

If you’re using the space for your operations, certain improvements may qualify for both bonus depreciation and Section 179 expensing. This is a complex issue best discussed with an accounting professional.

What is the IRS definition of “depreciable property”?

Here’s what the IRS has to say about what properties you can depreciate:

1. It must be a property you own
2. It must be used in your business or income-producing activity
3. It must have a determinable useful life
4. It must be expected to last more than 1 year

You can’t depreciate the land a property is on because it doesn’t get “used up” the way a building does. Without cost segregation, residential rental properties depreciate over 27.5 years and commercial properties over 39 years. Those rules have not changed.

Cost segregation strategies are now more valuable than ever.

You can reclassify components of a building or property to shorter depreciation periods using a process called “cost segregation.” Before July 2025, this meant accelerating deductions to 5, 7, or 15 years. With the new rules, you can combine that with 100% bonus depreciation for properties acquired and placed in service after January 19, 2025.

With 100% bonus depreciation permanent, cost segregation studies deliver 66% more value than they did in 2024. Every dollar reclassified to short-life property becomes immediately deductible.

ROI on cost segregation studies shows an effective increase of 66% for properties acquired after January 19, 2025.

Here’s the detailed process:

Step 1: Start with an inspection.

You’ll want to hire a qualified consultant for a cost segregation study. The consultant, often an engineer or architect, documents every system, fixture, and improvement that can be reclassified. They look for components that are “dedicated, decorative, or removable,” such as electrical systems, specialized HVAC systems, decorative finishes, and removable partitions.

Step 2: Categorize your assets.

Assets are categorized into groups based on their depreciable life.

Electrical systems are classified as five- or seven-year property, while the main building structure is classified as 27.5- or 39-year property.

Carpeting, decorative lighting, and specialized plumbing often fall into shorter categories. The building’s foundation, walls, and roof stay on the longer depreciation schedule.

Step 3: Create a schedule adjustment.

The IRS allows you to “catch up” on depreciation you could have claimed in prior years through a “look-back” study. You’ll need to file Form 3115 to change your accounting method if you’re applying cost segregation to a property you’ve owned for a while. That’s another task that my office can help you with. It’s best to discuss a change like that before implementing it.

Step 4: Calculate your immediate tax savings.

Here’s a realistic example:

1. Property value: $4,000,000 warehouse purchased in March 2025
2. Cost segregation findings: $800,000 in 5, 7, and 15-year property
3. Immediate deduction (100% bonus): $800,000 in year one
4. Tax savings at 37% rate: $296,000 in year one

Without cost segregation, that same $800,000 would have depreciated over 39 years at roughly $20,500 annually, saving $7,585 in taxes per year. Is cost segregation worth the expense? For properties valued over $500,000, absolutely. Studies typically cost between $5,000 and $15,000, depending on the property’s complexity.

Qualified production property is a new category for manufacturers to leverage.

The OBBBA created Qualified Production Property (QPP), which allows a 100% immediate deduction for nonresidential real property —meaning the actual building structure, not just its components. The requirements for QPP are:

• Construction must begin between January 20, 2025, and December 31, 2029
• Property must be placed in service before January 1, 2031
• Used in manufacturing, agricultural production, or chemical refining
• Located in the United States

Aesthetic vs. functional renovations are gray areas we need to think about.

The IRS doesn’t explicitly prohibit depreciating aesthetic improvements, but the improvement must be part of the building’s operation or necessary to maintain the property’s income-producing ability. Function and safety always win. Renovations that address code violations, improve accessibility, or upgrade failing systems are clearly depreciable.

Document the business purpose of every aesthetic improvement. If it helps attract tenants or meet market expectations, it supports your income-producing activity.

When in doubt, document the business purpose. If you’re renovating to attract higher-paying tenants or meet market expectations, keep records that show how the aesthetic improvements directly support your income-producing activity. A good example of this is repainting or adding exterior brick face or siding to improve a building’s curb appeal.

Home office renovations are a special case with specific rules.

Converting part of your home into a dedicated office space creates unique depreciation opportunities. The IRS allows you to depreciate the business-use percentage of your home, including renovations to that space, provided the space is used exclusively and regularly for business. 100% bonus depreciation is available for equipment and furniture.

Let’s look at what you shouldn’t do.

Understanding what not to do is just as important as knowing what to do. Here are some key mistakes you’ll want to avoid if you’re planning a renovation.

• Start work without documentation. No contracts, no invoices, no paper trail. When you’re trying to prove acquisition dates for 100% bonus depreciation eligibility, good luck without a written, binding contract.
• Ignore the placed-in-service date. Complete renovations in December, but don’t put them into use until March. You just delayed depreciation by an entire tax year, potentially costing six figures in year-one deductions.
• Sign contracts before January 19, 2025, for work completed after that date. Equipment ordered in December 2024 and installed in February 2025 only gets a 40% bonus, not 100%. Poor planning costs you 60% of potential deductions.
• Skip the cost segregation study because it costs money. You might save $300,000 in taxes with 100% bonus depreciation on reclassified components, but that $10,000 study fee seems steep. You’ll pay $300,000 in unnecessary taxes to save $10,000 on the study.
• Forget to adjust your basis when you sell. You took depreciation for years, which reduced your cost basis. Now you owe recapture taxes on the sale, and didn’t plan for it. Depreciation recapture gets taxed at 25% for real property.

Avoid these mistakes, and you’ll keep more of your renovation investment working for you rather than vanishing into tax penalties and missed deductions.

Get in contact with our team to maximize renovation depreciation.

The OBBBA has created the most significant depreciation opportunities in decades, but you may need expert guidance to capture them. Cost segregation studies, bonus depreciation calculations, QPP eligibility analysis, and strategic timing require specialized knowledge. 

Get this right, and you could save six or seven figures in taxes this year. Get it wrong, and you’ll leave massive deductions on the table. Schedule a discovery call to get started.

Talk soon,
Jeremy A. Johnson, CPA