# Cost segregation and a 1031 exchange A like-kind exchange defers gain on real property. Where section 1245 components fit, what counts as real property for section 1031, and what carries over. ## Short answer A section 1031 exchange defers gain on real property exchanged for like-kind real property held for business or investment. Since 2018 the section applies only to real property, and the question a cost segregation study raises is obvious: the study classified part of the building as section 1245 property for depreciation, so is that part still real property for the exchange? Under the regulations, usually yes for structural components and inherently permanent structures: the definition of real property for section 1031 is its own, and a structure or portion of one may be section 1245 property for depreciation and still be real property for the exchange. Movable personal property, such as furniture and equipment, is not real property and its transfer is outside the exchange. Gain is recognized to the extent of money or unlike property received, recapture applies to gain recognized, basis carries over with adjustments, and suspended passive losses are not released by a nontaxable exchange. This article walks the interaction. It is general education, and an exchange is a transaction your adviser and a qualified intermediary structure, not a tactic to apply from an article. ## Two definitions of "real property" | Question | Rule | Where the study's classifications land | |---|---|---| | Depreciation: what recovery period? | Section 1245 property versus section 1250 property, decided by function under the depreciation rules | Land improvements, equipment and certain building components are section 1245 property with short recovery periods | | Exchange: is it like-kind real property? | Real property means land, improvements to land, including inherently permanent structures and their structural components, natural products, and superjacent water and air space, under the section 1031 regulations | Structural components and inherently permanent structures are real property even if they are section 1245 property for depreciation; movable personal property is not | The regulations say it directly: a structure or a portion of a structure may be section 1245 property for depreciation purposes and still be real property for section 1031. The depreciation classification does not control the exchange classification. ## Sorting the asset list for an exchange A study's asset list is the starting point for the exchange analysis, which is one more reason the IRS guide expects a quality study to carry an organized list. - **Building, structural components, land improvements that are inherently permanent** such as paving, foundations, fencing set in the ground: real property for section 1031 whatever their depreciation class. - **Furniture, appliances, movable equipment, furnishings:** personal property, outside the exchange. Their transfer with the building is a separate taxable disposition of personal property with its own gain or loss and its own section 1245 recapture, and a corresponding purchase of personal property with the replacement building. - **Items on the line,** such as certain fixtures and equipment attached to the building: analyzed under the regulations' tests for inherently permanent structures and structural components. This is the adviser's and the intermediary's call, with the study's descriptions in hand. ## What is deferred and what is recognized Gain on the real property exchanged is deferred to the extent it is exchanged solely for like-kind real property. Gain is recognized to the extent of money or other unlike property received, often called boot, including debt relief not offset by debt assumed. Recapture follows recognition: on section 1245 property that is part of the exchange, the ordinary-income recapture applies to the extent gain is recognized, and unrecaptured section 1250 gain is taxed at up to 25 percent when recognized. Where no gain is recognized, the recapture potential carries into the replacement property rather than disappearing. The personal property that was outside the exchange is recognized in full: its gain, including section 1245 recapture, is taxed in the year of the exchange. ## Basis and depreciation after the exchange The basis of the replacement property is generally the basis of the property given up, adjusted for gain recognized and money paid or received. That carried-over basis, plus any additional basis from cash or new debt, is what the replacement property depreciates. How the carried-over basis and the excess basis are depreciated, and whether a new study on the replacement property is applied to the excess basis only or to the whole, involves the exchange regulations and elections your adviser makes. A new study on the replacement property produces an asset list for that building; the adviser decides how basis attaches to it. ## Suspended losses are not released A fully taxable disposition of the entire interest releases suspended passive losses. A like-kind exchange is not that. Suspended losses from the relinquished property carry to the activity that continues with the replacement property, and they are released later, on a taxable disposition. Owners who expected the exchange to free their carryforwards are surprised; plan for it. ## A sequence for owners considering an exchange 1. Give the adviser and the intermediary the study's asset list before the exchange is structured. 2. Sort the list: real property for section 1031, personal property outside it, items requiring analysis. 3. Model the recognized gain: boot, personal property outside the exchange, and the recapture on each. 4. Understand the carried-over basis and how depreciation of the replacement property will run. 5. Track suspended losses forward; they are not released. 6. Decide, with the adviser, whether and how a study on the replacement property applies. ## Common misunderstandings - "Everything the study reclassified is personal property, so it is all taxable in the exchange." No; structural components and inherently permanent structures are real property for section 1031 whatever their depreciation class. - "The exchange wipes out recapture." Recapture applies to gain recognized; unrecognized gain, including its recapture potential, carries over. - "The exchange releases my suspended losses." It does not. - "I can do a fresh 100 percent bonus study on the whole replacement property." Basis carries over with adjustments; the treatment of carried-over and excess basis is governed by the exchange regulations and elections. ## What people ask on Reddit and other forums Exchange questions in the "cost segregation reddit" threads on r/realestateinvesting are usually asked after the study, when the sale is near. The searches that lead people to these threads are usually phrased "cost segregation 1031 exchange", "1031 exchange depreciation recapture" and "section 1245 property 1031". **"Does cost seg kill my 1031?"** No. The depreciation classification does not control the exchange definition of real property; structural components and inherently permanent structures remain real property. **"What about the furniture?"** Movable personal property is outside the exchange and its transfer is a taxable disposition with section 1245 recapture. **"Do I pay recapture in the exchange?"** To the extent gain is recognized, for example through boot or the personal property outside the exchange. Unrecognized gain carries over. **"Can I bonus-depreciate the replacement building?"** The replacement property's basis carries over with adjustments; how carried-over and excess basis are depreciated is a question for your adviser under the exchange rules. ## Questions people also ask ### Is section 1245 property eligible for a 1031 exchange? Personal property is not, since 2018. But property that is section 1245 property for depreciation can still be real property for section 1031 if it is an inherently permanent structure or a structural component under the section 1031 regulations. ### Does a cost segregation study affect a 1031 exchange? It gives the adviser the asset list needed to sort real property from personal property and to compute recognized gain and recapture; it does not by itself make any component ineligible. ### Are suspended passive losses released in a 1031 exchange? No. They are released on a fully taxable disposition of the entire interest. ### What happens to depreciation recapture in an exchange? It applies to the extent gain is recognized; the rest carries over with the basis to the replacement property. ### Should I get a study on the replacement property? Often, but how the carried-over basis attaches to the new asset list is governed by the exchange rules. Ask your adviser before commissioning. ## Sources - https://www.law.cornell.edu/uscode/text/26/1031 — 26 U.S.C. §1031(a)(1). - https://www.law.cornell.edu/cfr/text/26/1.1031%28a%29-3 — 26 C.F.R. §1.1031(a)-3, definition of real property for section 1031. - https://www.irs.gov/publications/p544 — IRS Publication 544 (2025), Sales and Other Dispositions of Assets: Chapter 1 (like-kind exchanges), Chapter 3 (recapture), Chapter 4. - https://www.irs.gov/publications/p925 — IRS Publication 925 (2025), Passive Activity and At-Risk Rules: dispositions. - https://www.irs.gov/pub/irs-pdf/p5653.pdf — IRS Publication 5653, Cost Segregation Audit Techniques Guide (Rev. 2-2025): Chapter 4. ## Related reading - [Depreciation recapture after cost segregation](/articles/depreciation-recapture-after-cost-segregation) - [Cost segregation and selling within five years](/articles/selling-within-five-years) - [Passive loss carryforwards: what happens to suspended losses](/articles/suspended-passive-losses) - [Acquisition date vs placed-in-service date](/articles/acquisition-date-vs-placed-in-service-date) - [When to involve a tax adviser in cost segregation](/articles/when-to-involve-a-tax-adviser) - [What Reddit asks about cost segregation, answered with sources](/articles/cost-segregation-questions-from-reddit) - [Find a practitioner in the NBCSS directory](/directory) --- Canonical: https://nbcss.org/articles/cost-segregation-and-1031-exchange Published: 2026-09-25 · Last content change: 2026-09-25 Not professional advice: general educational information from the National Board of Cost Segregation Specialist (NBCSS); not accounting, tax, legal, financial, investment or engineering advice. Verify with a licensed CPA, enrolled agent, attorney or other qualified adviser before acting.