A sponsor emails the deck: "$12M acquisition, cost segregation study, projected first-year loss of 60% of invested capital." A limited partner writes a $100,000 check, receives a K-1 showing a $61,700 loss, and cannot deduct a dollar of it. Both facts are true at once. The loss is real, the study is legitimate, and the LP's return says zero. Understanding why is the difference between an investor who is delighted and one who feels misled.
Key takeaways
- The study is performed at the entity level, and the depreciation flows to partners on Schedule K-1 per the agreement's allocation provisions.
- Special allocations must have substantial economic effect under §704(b), or the IRS reallocates by the partners' interests.
- The loss is passive to a typical limited partner, who generally cannot establish material participation.
- A passive LP can use it against passive income from other investments; otherwise it suspends and releases on full disposition.
- Four gates apply in order: §704(d) basis, §465 at-risk, §469 passive activity, then §461(l) excess business loss. Marketing decks usually skip all four.
How the Deduction Reaches Your K-1
The partnership owns the building, so the partnership takes the depreciation. The study is engaged by the sponsor, performed on the entity's basis, and recorded on the entity's fixed asset schedule. What reaches you is your distributive share of the resulting loss. There is no election for you to make and no line item labeled "cost segregation."
So you cannot order a study on your partnership interest. If the sponsor did not run one, the deduction does not exist for you. Ask before you invest, and ask whether it is engineering-based, because the quality of the work determines how the position holds if examined.
Most agreements do not allocate the loss pro rata. Common structures give the LP class a disproportionate share of early-year losses, sometimes 99% or 100%, because that is what the LP class is paying for. Permitted within limits: a special allocation is respected only if it has substantial economic effect under §704(b), which requires properly maintained capital accounts and liquidating distributions that follow positive capital balances. Otherwise the IRS reallocates by the partners' interests.
The Four Gates Every K-1 Loss Has to Pass
A loss on your K-1 is a starting point, not a deduction.
§704(d) basis and §465 at-risk come first. You may deduct losses only up to your adjusted basis in the interest, capital contributed plus your share of partnership liabilities, and only to the extent you are economically at risk. Nonrecourse debt is normally not at-risk, but qualified nonrecourse financing secured by real property is, so in leveraged real estate neither gate usually binds.
§469 is where it stops. A limited partner generally cannot establish material participation, so the loss is passive and can only offset passive income. This is the gate the marketing deck never mentions; the mechanics are in our guide to the passive activity loss rules.
§461(l) applies last. If you clear §469, an aggregate net business loss above $256,000 single / $512,000 married filing jointly for 2026 is disallowed and becomes an NOL carryforward. Sponsors and materially participating general partners hit this constantly; see the excess business loss limitation.
A Worked Example: A $12M Multifamily Acquisition
Example: a $12,000,000 apartment community, placed in service mid-June Land allocated at $2,000,000, leaving $10,000,000 of depreciable basis. An $8,000,000 agency loan and $4,000,000 of LP equity. Permanent 100% bonus depreciation applies under §168(k).
| Class | Basis | Share | First-year deduction |
|---|---|---|---|
| 5-year personal property | $1,300,000 | 13% | $1,300,000 |
| 15-year land improvements | $1,200,000 | 12% | $1,200,000 |
| 27.5-year structure | $7,500,000 | 75% | $147,727 |
| Total | $10,000,000 | 100% | $2,647,727 |
The property generates $180,000 of income before depreciation for the stub year, so the partnership reports a taxable loss of $2,467,727. The agreement allocates 100% of year-one losses to the LP class, so a $100,000 investor holding 2.5% of the class sees roughly $61,700 on the K-1, about 62% of invested capital. The mid-June date matters: the structure contributes only $147,727 of that total under the mid-month convention.
Outside basis is $100,000 of capital plus a 2.5% share of the $8,000,000 qualified nonrecourse loan, so §704(d) and §465 are satisfied. §469 is not.
| LP's passive income from other investments | Deductible in year one | Suspended |
|---|---|---|
| $0 | $0 | $61,700 |
| $25,000 | $25,000 | $36,700 |
| $75,000 | $61,700 | $0 |
Read the bottom row carefully. Nothing about the engineering changes across those three rows; only the investor's other passive income does.
What a Limited Partner Can Actually Do With the Loss
Three things, precisely.
Offset passive income from other investments. Other syndications, directly owned rentals, and other passive activities all qualify. Investors holding a portfolio of deals frequently use these losses in full, netting losers against winners each year.
Carry it forward. A suspended loss carries forward indefinitely against passive income from the same activity, which matters because a deal that loses money in years one and two often produces passive income by year four.
Release it on full disposition. When the partnership sells and liquidates, or you dispose of your entire interest in a fully taxable transaction to an unrelated party, suspended losses are freed and deductible against income generally. That is the real payoff, and it lands at exit.
What you cannot do is offset your salary. Price in one more item: the deduction reduces your capital account and outside basis, so more gain appears at exit. The 5- and 15-year assets produce §1245 ordinary recapture at rates up to 37%; the structure produces unrecaptured §1250 gain taxed at a maximum 25%. See our piece on depreciation recapture.
The Sponsor's Side: A Real Advantage, Honestly Modeled
Now that 100% bonus depreciation is permanent under OBBBA, a first-year loss no longer shrinks with each year of a phase-down. It is a durable, repeatable feature of the offering, and the current bonus depreciation landscape makes it easy to model across a fund's life.
That advantage carries an obligation. Offering materials should present the loss as a percentage of invested capital and state plainly that it is passive to a typical LP, that its use depends on the investor's own passive income, and that suspended losses release at disposition. Sponsors who say this get fewer angry March calls and more repeat capital. Two operational notes: order the study in the acquisition year, and give investors' CPAs the asset detail schedule.
Where the Pitch Deck and the Tax Return Part Ways
Read enough offering memoranda and you will see the same line: "projected year-one depreciation of 55% to 70% of invested capital." Accurate as an entity-level statement, useless as a personal one.
For a passive LP with no other passive income, the year-one deduction is zero. Not reduced. Zero. The loss sits suspended until passive income appears or the deal exits, so an investor who bought partly for the first-year tax benefit has bought a benefit deferred five to seven years.
Ask three questions before wiring funds. Do I have passive income this year to absorb it? If not, when? And is the hold long enough that release at disposition still matters? No dishonesty is required to get this wrong. There is a gap between what a partnership computes and what an individual can deduct, and closing it is the sponsor's job before it becomes the investor's problem.
Frequently Asked Questions
Can a limited partner ever materially participate?
Difficult by design. A limited partner's participation is tested under a narrow set of the material participation tests, and passive treatment is the practical default for a check-writing investor. Sponsors and managing members who operate the asset are in a different position entirely.
Can I request a study on my partnership interest?
No. The study applies to the entity's basis, and only the partnership can commission it. Ask during diligence whether one is planned, whether it is engineering-based, and in which tax year it lands. If the property was acquired earlier, a look-back remains available.
Do suspended losses release on a refinance or a single-property sale?
A cash-out refinance does not release them, and a sale of one property by a multi-asset partnership generally does not either, because release requires a fully taxable disposition of your entire interest in the activity.
See What Your Property Would Yield
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This article is provided by Precision Cost Segregation for general educational purposes and does not constitute tax, legal, or accounting advice. Tax outcomes depend on your specific facts, your tax rate, your passive activity position, and your entity structure. Figures shown are illustrative. Consult your CPA or tax advisor before acting, and engage a qualified professional to perform any cost segregation study. Information is current as of publication.
This article is general information, not tax or legal advice. Depreciation outcomes depend on your facts, elections, and current law — consult your CPA before acting. © 2026 Precision Cost Segregation.