Commercial Real Estate Cost Segregation & Financing

The number behind the headline

The Mortgage Bankers Association estimates that $875 billion of commercial and multifamily mortgages is scheduled to mature in 2026. That is about 17% of the $5.0 trillion outstanding. It is down from the $957 billion that was scheduled for 2025, but the smaller number is a little misleading. A good share of this year's maturities are loans that already got extended once or twice while everyone waited for rates to come back down.

They didn't come back down much. In mid-September the 10-year Treasury was pushing toward 5%, its highest level since 2023. Permanent financing for a solid, stabilized property is pricing somewhere in the 6s, and higher for anything with a story. Most of the loans coming due were written at 3% to 4.5%.

Same building, same rent, smaller loan

This is the part owners don't see coming until the term sheet shows up. You can run a clean building with no vacancy problem and still come up short at refinance.

Here's a simple example. In 2021 an owner financed a neighborhood retail center with a $7.2 million, five-year loan at 3.75% on a 30-year amortization. Net operating income was $600,000. Debt service ran about $400,000 a year, so the debt service coverage ratio was 1.50x. Nobody lost any sleep over that loan.

Now fast forward to maturity. Five years of amortization brought the balance down to roughly $6.49 million. NOI is still $600,000; the owner didn't lose a tenant. But re-price that same balance at 6.75% and debt service jumps to about $505,000. Coverage falls to 1.19x. Most lenders want 1.25x on a property like this, and at 1.25x the building supports a loan of about $6.17 million.

That leaves a gap of about $318,000. The owner has to bring it to closing, raise expensive mezzanine or preferred equity, or sell. Nothing went wrong with the property. The math changed.

Multiply that by a few thousand borrowers and you get the year we're in.

Why "extend and pretend" ran out of road

In 2023 and 2024 a lot of lenders chose extensions over foreclosures. The borrower paid a fee, maybe bought a rate cap, maybe paid the balance down a little, and everyone bought another year or two. That made sense when the consensus called for rate cuts.

A third extension is a harder sell. Bank examiners are asking more questions about the loans sitting on the books, and CMBS special servicers have less patience than they did two years ago. So the refinance a lot of owners put off is now the refinance they have to do.

Where the equity is supposed to come from

When the new loan comes up short, the difference has to be filled with cash. The usual sources:

• Your own liquidity. Fine if you have it, though most owners would rather keep their reserves where they are.
• A capital call on your partners. Nobody enjoys making that phone call.
• Mezzanine debt or preferred equity. Available, but often priced in the low-to-mid teens, which eats the returns that justified the deal in the first place.
• Selling. Sometimes the right answer, but selling into a market where buyers price off 6.75% debt usually means taking a haircut.

There is one more source a lot of owners overlook: the federal income tax they're about to pay anyway.

How cost segregation fits

A cost segregation study is an engineering-based analysis that breaks a building down into its components. The structure itself is depreciated over 27.5 years for residential rental property or 39 years for commercial. But a real share of what you paid for isn't structure. Carpet and vinyl flooring, cabinetry, dedicated electrical, decorative lighting, parking lots, sidewalks, landscaping, and site utilities all qualify for 5-, 7-, or 15-year lives.

On a typical property, 20% to 40% of the depreciable basis can be moved into those shorter lives. Under the tax law passed in July 2025, property acquired after January 19, 2025 qualifies for 100% bonus depreciation, so those reclassified components can be written off in the first year.

Bought the building years ago? You can still do a study. An automatic accounting method change lets you pick up the depreciation you missed, all in the current tax year, without amending prior returns.

Go back to the retail center. Say the owner paid $9 million in 2021 and 20% of that is land, leaving $7.2 million of building. If a study moves 30% of the building, about $2.16 million, into shorter lives, the catch-up deduction this year could run close to $1.9 million after accounting for the straight-line depreciation already taken. For an owner in the 37% bracket who can use the loss, that's roughly $700,000 of federal tax savings. That covers the $318,000 gap twice over, with room left for reserves.

The caveats, because there are always caveats

• The savings only help if you can use them. Passive activity rules limit a lot of investors. Real estate professionals, and owners with enough other passive income, get the full benefit. Talk to your CPA before you count on the money.
• Depreciation isn't free. When you sell, part of it gets recaptured. For most long-term holders, the deferral is still well worth it, and a 1031 exchange can push the bill out further.
• Lenders size loans on NOI, not on your tax return. A study doesn't change the DSCR a lender calculates. What it does is put cash in your hands, and that cash can pay the balance down to where the math works, fund required reserves, or buy down the rate.
• States vary. Kentucky and a number of other states don't follow federal bonus depreciation, so the state-level savings are smaller.

What to do if your loan matures in the next 18 months

1. Get your maturity date, current balance, and trailing-12-month NOI in one place.
2. Run the refinance at today's rates, not the rate you're hoping for.
3. If there's a gap, find out what a cost segregation study could produce before you decide how to fill it.
4. Line up the timing with your CPA so the savings land in the tax year you need the cash.

Studies take a few weeks, and refinances rarely wait for anyone. The owners who come through this year in good shape will be the ones who ran the numbers early.

First, what DSCR actually measures

Debt service coverage ratio is net operating income divided by annual debt service. NOI is your rent and other income minus operating expenses. It's calculated before the mortgage payment, before depreciation, and before income taxes.

A DSCR of 1.25x means the property's NOI covers the mortgage payment with a 25% cushion. Most lenders want somewhere between 1.20x and 1.35x, depending on the property type. Hotels and single-tenant deals tend to sit at the higher end.

Clearing up a common misunderstanding

You'll see marketing that implies a cost segregation study raises your NOI. It doesn't. Depreciation is a non-cash expense, and it sits below the NOI line. A lender underwriting your building gets the same NOI whether you've done a study or not.

So how does cost segregation help your coverage? A ratio has two parts. Cost segregation can't touch the top number, NOI. It works on the bottom number, debt service, by producing cash you can use to shrink the loan, buy down the rate, or both. It also makes your personal financial picture look stronger when the lender reviews you as the sponsor.

Here's how that plays out, step by step, on a real-world-sized deal.

Step 1: Start with where the loan stands today

An owner bought a light industrial flex property in 2022 for $13 million and financed $10 million at 3.50% on a 30-year amortization. The payment was about $44,900 a month, or $538,900 a year. NOI was $780,000, so the DSCR was a comfortable 1.45x.

The loan matures in 2026. After four years of payments, the balance is about $9.19 million.

Step 2: Re-price the balance at today's rates

Put that same $9.19 million balance at 6.75% and the payment climbs to about $59,600 a month, or $715,300 a year.

DSCR: $780,000 ÷ $715,300 = 1.09x. The building didn't change. The coverage did, and 1.09x won't get a loan approved.

Step 3: Find the loan the property will actually support

The lender wants 1.25x. Work backward:

• Maximum annual debt service: $780,000 ÷ 1.25 = $624,000
• That's $52,000 a month
• At 6.75% on a 30-year amortization, $52,000 a month supports a loan of about $8.02 million

The owner owes $9.19 million and can borrow $8.02 million. The gap is about $1.17 million.

Step 4: Size the cost segregation benefit

The purchase price was $13 million. Allocate 20% to land and the depreciable building basis is $10.4 million. As commercial property, the owner has been depreciating all of it over 39 years.

A cost segregation study identifies 32% of that basis, about $3.33 million, as 5-, 7-, and 15-year property: interior finishes, dedicated electrical for equipment, the parking lot, site lighting, and landscaping.

Because the property was placed in service in 2022, a year when bonus depreciation was 100%, the owner can file for an automatic accounting method change and take a catch-up deduction this year. After backing out the roughly $330,000 of straight-line depreciation already claimed on those components, the catch-up is about $3.0 million.

At a 37% federal rate, that's about $1.11 million in tax savings, provided the owner can use the loss. (More on that below.)

Step 5: Put the cash to work on the loan

The owner brings $1.17 million to closing: $1.11 million from the tax savings and about $60,000 from reserves. The new loan is $8.02 million at 6.75%. Annual debt service is $624,000, and the DSCR is 1.25x.

The refinance closes without mezzanine debt, without a capital call, and without a forced sale.

Some owners split the money differently. They pay down a little less and use part of the savings to buy down the rate, which lowers debt service from the other direction. Ask your lender to price both ways and compare the payment and the prepayment terms side by side.

Step 6: Get the timing right

This is the step people get wrong. The tax savings don't show up as a check the day the study is finished. They show up as a lower tax bill, which means:

• Your CPA can reduce your quarterly estimated payments once the study is in hand, so cash stays in your account during the year.
• The accounting method change is filed with the tax return for the year of change, including extensions.
• If your maturity date comes before the savings are realized, you may need a short extension or a line of credit to bridge a few months.

A study typically takes three to six weeks. If your loan matures in the next year, start now.

What the lender will look at on your side

Most commercial lenders look at the sponsor's global cash flow, which means your personal tax returns. A large cost segregation loss can make a return look alarming to an analyst who reads it too quickly. An experienced underwriter adds depreciation back, but don't leave that to chance. Give your loan officer a one-page summary of the study showing that the loss is non-cash.

The tax savings also help with post-closing liquidity requirements. Many lenders want to see six to twelve months of debt service in the sponsor's accounts after closing, and cash you didn't send to the IRS counts.

When this won't work

• You can't use the losses. If you're a passive investor without other passive income and you don't qualify as a real estate professional, the deduction is suspended and carried forward. It still has value, just not this year.
• The building is small. Below roughly $200,000 of building cost, the study fee can eat much of the benefit.
• You're selling soon. If you plan to sell in a year or two, recapture shrinks the net benefit. Run the numbers with your CPA.

If none of those apply, cost segregation is one of the few tools that can close a refinance gap using money you were going to send to the Treasury anyway.

Why the refinance is the right time to bring it up

Clients call their CPA when they have a tax problem and their banker when they have a loan problem. In 2026 those two problems are showing up at the same time. With $875 billion in commercial mortgages maturing this year, plenty of your real estate clients are about to learn that their building supports a smaller loan than the one they have. The question of where the paydown money comes from is going to land on your desk eventually. It's better to raise cost segregation before the term sheet arrives than after.

Here is what I'd want a CPA to know before that conversation.

What a defensible study looks like

The IRS Cost Segregation Audit Techniques Guide lays out 13 principal elements of a quality study, and examiners use it. The legal foundation goes back to Hospital Corporation of America v. Commissioner (1997), which confirmed that building components can qualify as tangible personal property under the old investment tax credit rules.

A study you can stand behind should include:

• A site inspection by someone qualified to identify building components
• A reconciliation of the study total to the client's actual basis
• An asset-by-asset schedule with class lives and the reasoning behind each classification
• Cost support from construction records or, when those don't exist, a recognized cost-estimating method

Be wary of "studies" that apply a flat percentage by property type with no site visit. They're cheap for a reason, and they won't hold up in an exam.

Bonus depreciation after the 2025 tax law

The legislation signed in July 2025 made 100% bonus depreciation permanent for qualified property acquired after January 19, 2025. The acquisition date is the date of a written binding contract, not the closing date. That matters. Property under contract before January 20, 2025 still falls under the old phase-down: 40% for property placed in service in 2025 and 20% in 2026.

Qualified improvement property remains 15-year property and is eligible for bonus. Your client can still elect out of bonus by class if a slower deduction fits their plans better, for example if they expect to be in a higher bracket in later years.

Existing properties: Form 3115 and the §481(a) adjustment

For buildings your client already owns, you don't need to amend anything. The change from depreciating components over 27.5 or 39 years to their correct shorter lives is an automatic accounting method change (DCN 7). You file Form 3115 with a timely filed return for the year of change, including extensions, and send a duplicate copy to the IRS.

The negative §481(a) adjustment, meaning all the depreciation the client should have taken in prior years, comes in entirely in the year of change. For a refinance, that gives you some flexibility: you can choose the tax year so the savings arrive when your client needs the cash.

One nuance: if the property was placed in service in a year when bonus applied, such as 2018 through 2022 at 100%, the catch-up generally reflects bonus the client didn't claim, unless they elected out that year.

Who can actually use the losses

This is where most of the value is won or lost, and it's your call, not the cost segregation firm's.

• Passive activity rules (§469). Rental activity is passive by default. The $25,000 special allowance for active participants phases out between $100,000 and $150,000 of modified AGI, so it doesn't help most commercial owners.
• Real estate professional status. More than 750 hours and more than half of the client's personal services in real property trades or businesses, plus material participation. Clients who qualify can use the losses against other income.
• Short-term rentals. With an average stay of seven days or less and material participation, the activity may not be a rental activity under §469.
• Excess business loss limitation (§461(l)). Even a real estate professional can hit this cap on noncorporate losses against wages and investment income. Model it.

Suspended losses aren't wasted. They carry forward and free up on disposition. But they won't fund a paydown this year, and the refinance timeline depends on money that's available now.

Recapture and disposition planning

Components reclassified to 5-, 7-, and 15-year property are §1245 property. On a sale, the depreciation on them is recaptured at ordinary rates. Depreciation on the structure is unrecaptured §1250 gain, taxed at up to 25%.

A few ways to manage that:

• Allocate the sales price to components at sale, supported by an appraisal. Used carpet from 2019 isn't worth its original cost.
• A 1031 exchange defers the whole thing.
• Assets held until death get a step-up in basis.
• The partial disposition election under Reg. §1.168(i)-8 lets your client write off the remaining basis of a roof or HVAC system when it's replaced. The study gives you the component basis you need to do that.

State conformity

Kentucky doesn't follow federal bonus depreciation, and neither do a number of other states. Keep separate state depreciation schedules and set expectations: the state savings will be smaller and spread out.

Help the lender read the return correctly

Commercial lenders review the sponsor's personal returns for global cash flow. A seven-figure depreciation loss can alarm an analyst who reads it too fast. Good underwriters add depreciation back, but a short CPA letter explaining that the loss is non-cash, along with the study summary, saves a round of questions and sometimes a week of closing time.

A word on referral arrangements

If you're considering a referral fee from a cost segregation provider, check the rules first. Under the AICPA Code of Professional Conduct (ET 1.520), commissions are prohibited when you perform attest services for the client and must be disclosed otherwise. Many state boards are stricter than the AICPA. Our firm requires written confirmation of compliance with your professional and state rules before any referral compensation is paid.

A pre-refinance checklist

1. Loan maturity date, current balance, and trailing-12-month NOI
2. Acquisition date, purchase price, and any contract date near January 19, 2025
3. Land allocation and any capital improvements since acquisition
4. The client's passive activity position and real estate professional status
5. Expected hold period and exit plan
6. State conformity and the target tax year for the method change

Get those six items together and you can tell your client within a day whether a study is worth doing before the refinance.