California Decouples From Federal Bonus Depreciation – Why a Cost Segregation Study Still Pays

If you are a real estate investor, it's likely you are already aware that the tax rules in California are among some of the most complex in the United States. The most relevant recent difference between tax rules in California and federal tax rules relates to bonus depreciation.

The One Big Beautiful Bill Act, P.L. 119-21, made 100% bonus depreciation permanent for qualifying property acquired and placed in service on or after 20 January 2025, reversing the phase-down that had been stepping the rate down through 80%, 60%, 40%, 20% and finally 0%. However, the California Franchise Tax Board has specifically stated it will not conform to federal tax rules under IRC section 168(k), which includes the federal bonus depreciation that the OBBBA would apply. Even so, a California cost segregation study can still prove beneficial for real estate investors in the state.

Before we understand what it means to decouple from it, we should understand what bonus depreciation is. Essentially, bonus depreciation allows property and business owners to deduct a large portion of the cost of an eligible property from their tax payments, much sooner than would be normal due to property depreciation rates.

California does not follow these tax rules.

Despite the fact that California moved its conformity to federal tax rules to 1st January 2025, it is still decoupled, meaning that it does not abide by several distinct federal tax rules that have been enacted after that date. The OBBBA, most notably.

Consider a client who acquired a California apartment building in 2019 for $5,025,781, with land valued at $3,050,449. A full engineering-based cost segregation study produced an estimated $340,955 in first-year tax savings and a 90:1 payback ratio.

Even if California will not allow for the bonus depreciation, federal taxes may still allow for accelerated deductions on qualifying property. For real estate investors with large rental properties or portfolios in their name, these deductions can add up.

Decoupling reduces the state-level bonus benefit to zero. It does not eliminate the value of reclassification. Federally, qualifying components are expensed immediately. On the California return, those same components still depreciate over 5, 7, and 15 years rather than 27.5 or 39 — which is genuine acceleration, simply without the bonus layer on top.

Typically, a study reclassifies 20% to 30% of depreciable basis, with 15% to 25% common on residential property and 20% to 35% on commercial property. Five-year property covers removable finishes and equipment, seven-year covers certain personal property by class life, and 15-year covers land improvements such as parking areas, sidewalks, landscaping and irrigation, site lighting and fencing. Structural components — foundations, framing, load-bearing walls, roofs — remain on the long schedule.

The federal cash flow this frees up is precisely what an owner uses to absorb California's rates of 8.84% corporate and up to 13.3% individual.

In practice, this means running two schedules. The full bonus deduction is claimed on the federal return, then the entire bonus amount is added back on the California return, and California depreciation is computed separately from there. Over the asset's life the total deduction is the same under both systems — only the timing differs.

A California Schedule A adjustment can help property owners to ensure that their depreciation benefits are correctly reported for both state and federal taxes. California depreciation may exceed federal in later years because the federal basis was reduced.

Accelerated depreciation is a timing benefit, not a permanent one, and the reckoning comes at sale. The 5- and 7-year personal property a study reclassifies is Section 1245 property, recaptured at ordinary income rates up to 37%. The 15-year land improvements and the building itself are Section 1250 property, where depreciation claimed in excess of straight-line is ordinary income, and the straight-line portion becomes unrecaptured Section 1250 gain, capped at 25%. Recapture can be deferred through a Section 1031 exchange. This is why hold period matters: a study generally makes sense on a three-to-five-year minimum hold, and is most compelling at five years or longer.

One caveat matters more in California than almost anywhere else. Accelerated deductions are not automatically usable against other income. Under IRC Section 469, losses from rental activity are generally passive, which means they suspend and carry forward against future passive income, or release on disposition, rather than offsetting wages or business income in the year they arise. Two exceptions apply.

Real Estate Professional status under Section 469(c)(7) requires more than 750 hours annually in real property trades or businesses, more than half of total working time, and material participation.

Separately, the short-term rental exception under Reg. 1.469-1T(e)(3)(ii)(A) applies where average guest stay is seven days or less, and the owner materially participates.

High-earning California professionals frequently assume a study will offset W-2 income. Without qualifying under one of these routes, it will not.

As a note, this is general information, and readers should consult a qualified California tax professional.