Cost Segregation · Brief · Pro level
Buying real estate from a related party: the depreciation rules that switch off
Related-party acquisitions forfeit Section 179 expensing, fail the bonus depreciation used-property acquisition requirements of Section 168(k)(2)(E)(ii), and can import carryover basis and disallowed-loss taint. A cost segregation study still works on such property — but the acceleration tools it usually feeds do not.
Selling the family building to the family operating company — or to the kids' new LLC — looks like a fresh purchase with a fresh depreciation start. The Code disagrees at three separate checkpoints. Section 179 expensing is off: Section 179(d)(2) excludes property acquired from related persons. Bonus depreciation on used property is off: Section 168(k)(2)(E)(ii) conditions bonus for used property on the same Section 179(d)(2) acquisition tests, plus a no-prior-use rule and a no-carryover-basis rule. And where the transfer is not a true sale — a contribution, a gift, a distribution — Section 168(i)(7) makes the transferee depreciate carryover basis exactly as the transferor was, no restart at all. A cost segregation study remains fully available; what disappears is most of the acceleration the study normally feeds.
The three checkpoints
Section 179. The expensing election never applies to property acquired from a related person, with relatedness defined through Sections 267(b) and 707(b) — modified so that more-than-50-percent ownership, with family attribution among spouses, ancestors, and lineal descendants, triggers the bar. Since the TCJA extended Section 179 to roofs, HVAC, fire protection, and security systems on nonresidential real property, this exclusion now bites real estate deals, not just equipment.
Bonus on used property. The TCJA opened bonus to used property, but only through the gate of Section 168(k)(2)(E)(ii): the taxpayer (or a predecessor) must not have used the property before, the acquisition must satisfy Section 179(d)(2)(A)–(C) — not from a related person, not from a controlled-group member, not with a basis determined by the seller's basis or under Section 1014 — and must not be from a decedent. Treas. Reg. §1.168(k)-2(b)(3) elaborates, with series-of-transactions and anti-churning style rules that test relatedness at each step of multi-party chains; inserting an unrelated intermediary rarely survives the regulation's step-transaction treatment. Note the asymmetry: new, never-placed-in-service property is not subject to the used-property tests — a related developer selling a just-completed building can still deliver bonus-eligible property, because the acquisition requirements for used property simply do not apply to original-use property.
Carryover basis. Contributions under Section 351 or 721, partnership distributions, and gifts do not restart depreciation at all: under Section 168(i)(7) the transferee steps into the transferor's shoes for the carryover portion of basis — same lives, same method, same remaining schedule. Only basis in excess of the carryover amount (gain recognized, new money) is treated as newly placed in service. And Section 267(a) lurks behind actual sales: a loss on a sale to a related buyer is disallowed, while gain-side sales between certain related parties face Section 1239, which converts the entire gain on depreciable property into ordinary income — a seller-side cost that routinely kills the deal economics before depreciation is even discussed. See depreciation recapture explained for how §1239 compares to ordinary recapture.
What is left for cost segregation
A $4,000,000 used building bought from a related entity versus an unrelated seller (20% to 5-year, 10% to 15-year; illustrative, first-year figures).
| Item | Unrelated seller | Related seller |
|---|---|---|
| 5-year property ($800K) | $800,000 (100% bonus) | ~$160,000 (MACRS, no bonus) |
| 15-year property ($400K) | $400,000 (100% bonus) | ~$20,000 (MACRS, no bonus) |
| 39-year residual | ~$66,000 | ~$66,000 |
| Year-one total | ~$1,266,000 | ~$246,000 |
The related-party column is not nothing — $246,000 beats the ~$95,000 an unstudied 39-year schedule would produce, and the study's shorter lives keep paying for years. But it is a fraction of the bonus-eligible case, and the fee-versus-benefit analysis in when a study makes sense should be rerun with bonus switched off before anyone signs an engagement letter. Confirm the relationship analysis in writing — the Section 267 attribution rules produce surprising relatedness through trusts, entities, and family chains — and keep the transferor's depreciation schedules in the file for any carryover-basis component, since Form 4562 reporting must continue them, not restart them. Pub 946 states the related-party and carryover rules in plain terms; examiners check the acquisition-source question before they check a single component classification.
Frequently asked questions
- Is property bought from a related party eligible for bonus depreciation?
- Generally no, if it is used property. Section 168(k)(2)(E)(ii) requires used property to meet the acquisition tests of Section 179(d)(2) — the property cannot be acquired from a related person as defined through Sections 267 and 707(b), cannot come from a controlled-group member, and cannot take a carryover or decedent-determined basis. New, never-used property can still qualify, but a building a family entity has depreciated fails the used-property tests in the buyer's hands.
- Does Section 179 apply to purchases from related parties?
- No. Section 179(d)(2) excludes property acquired from a person whose relationship to the buyer falls under Section 267 or 707(b), applying Section 267 with a more-than-50-percent family-and-entity standard. Qualifying real property improvements — roofs, HVAC, security systems on nonresidential buildings — that would otherwise be Section 179-eligible lose that treatment when purchased from a related seller.
- Can you still do a cost segregation study on property acquired from a related party?
- Yes. MACRS classification does not depend on where the property came from — a study still moves basis into 5-, 7-, and 15-year classes with faster regular depreciation. What the related-party rules remove is bonus depreciation and Section 179 on the reclassified property, and in carryover-basis transactions (Section 351, 721, gifts) the transferee largely steps into the transferor's existing depreciation schedule under Section 168(i)(7).