Depreciation and Bonus Depreciation in DST 1031 Investments

Reg. 1.168(i)-6 splits your DST basis into exchanged basis on the old clock and excess basis on a new one

Exchanged basis is the lesser of your basis in the DST interest and the adjusted depreciable basis of the property you gave up; excess basis is everything above it. The exchanged portion is depreciated over the remaining recovery period of the relinquished property, using its method and convention, as if you had never sold; the excess portion is treated as property placed in service in the year the exchange closed.

Because Rev. Rul. 2004-86 treats you as owning an undivided fractional interest in the trust's real estate, these rules apply to your slice exactly as they would to a building you bought alone. The sponsor's tax package can only supply your share of the trust's cost and its component allocation; your CPA assembles the two schedules from that and from your Form 8824.

Two special cases change the clock. If the property you sold was 27.5-year residential and the DST holds 39-year nonresidential property, the exchanged basis is depreciated as though it had been 39-year property from its original placed-in-service date. Going the other way, from commercial into a multifamily DST, the exchanged basis keeps the 39-year period rather than shortening to 27.5.

A worked example: $1,000,000 into a commercial DST after selling a rental with $200,000 of building basis left

Hypothetical, round numbers, ignoring first-year conventions. You bought a rental in 2010 with $400,000 allocated to the building, took 16 years of 27.5-year depreciation and sold in 2026 with $200,000 of building basis left and about 11.5 years on the schedule. You exchange the full $1,000,000 sale price into a 39-year commercial DST.

The $200,000 exchanged basis now follows the longer period: it is written off as though it had been 39-year property since 2010, so roughly 23 years remain and the deduction falls to about $8,700 a year from about $17,400. The $800,000 excess basis is new property, and the sponsor's allocation decides how much of it depreciates: at 20% land, 70% structure and 10% short-life components, $160,000 never depreciates, $560,000 yields about $14,400 a year over 39 years, and $80,000 of 5-, 7- and 15-year components is eligible for 100% bonus in year one.

Year-one depreciation on this interest is therefore about $103,000, most of it bonus, and about $23,000 a year afterward. Without a component allocation the same purchase produces about $25,000 in every year, which is the entire value of asking the sponsor for the study.

Bonus depreciation is back at 100% for property acquired after January 19, 2025, but it never touches the building shell

Public Law 119-21, section 70301, struck the phase-down and made the 100% allowance permanent for property acquired after January 19, 2025, with a one-time election to use 40% in the first tax year ending after that date. Acquisition follows the written binding contract date, so a DST that contracted for its property before January 20, 2025 may still be under the old percentages even if it closed later.

Section 168(k)(2)(A) limits qualified property to items with a recovery period of 20 years or less. A 27.5-year apartment building or a 39-year warehouse can never take bonus depreciation; only the carpet, cabinetry, specialty electrical, site paving and landscaping that a cost-segregation study reclassifies into 5-, 7- and 15-year classes can. The IRS cost-segregation audit guide, Publication 5653, describes exactly that reclassification and warns that the allocation of building components to section 1245 property is often contested.

For a used building bought through an exchange, only the excess basis qualifies for bonus, so carried-over basis gets none

Reg. 1.168(k)-2(g)(5)(iii)(A) draws the line: when replacement property meets the used-property acquisition rules, only the remaining excess basis is eligible for the additional first-year deduction, and both the exchanged and excess basis qualify only when the property meets the original-use test, meaning the trust bought it new. Most DSTs buy stabilized, previously occupied buildings, so an investor with a large carried-over basis should expect bonus on the new money alone.

Electing out of Reg. 1.168(i)-6 under paragraph (i), which treats the whole basis as newly placed in service, does not change that result; paragraph (g)(5)(iii)(D) of the bonus regulation keeps the exchanged basis ineligible for used property even after the election. The election can still simplify two schedules into one, at the cost of a longer write-off of the carried-over amount.

One caution for 2026 filings: the bonus regulation's text still recites the pre-2025 sunset dates from the 2017 law, and the version we read had not been conformed to Public Law 119-21. The statute as amended controls, but ask your CPA how the firm is applying the used-property rule to acquisitions after January 19, 2025.

Cost segregation, land allocation and passive limits decide how much of the deduction you can actually use

Three questions to settle with the sponsor and your CPA before the exchange closes:

• Land share: Publication 527 makes land non-depreciable, and the split among land, structure and components in the sponsor's tax package is the only allocation your CPA will have; a high-land-value location pushes more of your basis into the non-depreciable line.
• Cost-segregation study: ask whether the sponsor commissioned one and whether its component classes are reported per investor; without it the excess basis is all 27.5- or 39-year structure and the bonus line is zero.
• Passive character: a large bonus deduction on a leveraged trust can produce a net tax loss, and under section 469 that loss offsets only passive income; the passive loss page covers what it can absorb and what happens on sale.

What the depreciation you take now costs when the trust sells or exchanges

Every dollar of depreciation, bonus included, reduces basis and returns as gain when the trust's property is sold without another exchange; straight-line depreciation on the building comes back as unrecaptured section 1250 gain and bonus on section 1245 components comes back as ordinary income. Exchanging again defers both layers, and the sale page walks through the choice.

If the plan is to hold until death, the step-up in basis erases the deferred gain and the recapture together, which is why heavily depreciated DST positions sit at the center of the estate planning page. Confirm the schedules and the recapture math with your CPA or attorney before relying on any figure here.