Understanding Bonus Depreciation
Bonus depreciation is a tax provision that permits businesses to deduct a substantial portion of the purchase price of eligible assets, including real estate, in the year the assets were put into service. The Tax Cuts and Jobs Act of 2017 amplified the impact of bonus depreciation, allowing a 100% deduction of the cost of eligible property in the year it was placed in service.
This provision has been a game-changer for real estate investors, enabling significant reductions in taxable income and, consequently, the tax bill. When combined with cost segregation—a strategy that involves identifying and separating personal property assets and land improvements from real property assets to accelerate depreciation deductions—bonus depreciation becomes even more powerful.
The Impending Phase-Out of Bonus Depreciation
However, the landscape is set to change. The generous provisions of the Tax Cuts and Jobs Act are starting to phase out. The 100% bonus depreciation will be reduced each year until it is completely phased out.
This phase-out will have a profound impact on real estate investors. The immediate tax savings from bonus depreciation will be reduced, potentially affecting cash flow and return on investment calculations. It may also impact decisions about when to buy or sell property, as the timing could significantly affect the available tax benefits.
Implications for Cost Segregation
The phase-out of bonus depreciation will also have implications for cost segregation strategies. With the reduction of bonus depreciation, the benefits of cost segregation may be less pronounced. However, cost segregation will continue to be a valuable strategy for real estate investors. It will still allow for accelerated depreciation deductions on certain property assets, which can still result in substantial tax savings.
Conclusion
As bonus depreciation is phasing out, it’s causing significant changes in the tax landscape for real estate investors. Nevertheless, we believe that in many cases, investors can obtain much of the same tax benefit by employing cost segregation. This strategy will offer you benefits comparable to bonus depreciation, but they will be received over a 3-5 year period rather than in the first year.
At present, savvy real estate investors with positive rental income should contemplate acquiring more property to increase the deductions they will receive. This approach can be effective for both large and small investors. By utilizing this depreciation benefit, investors can frequently achieve taxable equivalent returns of between 8% and 12%.
Whether you’ve relied heavily on bonus depreciation in the past or not, we can design an investment plan that will allow you to maximize your depreciation options. At Exchange Planning Corporation, we’re committed to helping our clients navigate these changes. Our expert team is prepared to offer guidance and support to ensure your real estate investments remain as tax-efficient as possible. Don’t hesitate to reach out to us for a consultation on how these changes may affect your investment strategy.
FAQ
- What is bonus depreciation in real estate investing?
- Bonus depreciation is a tax provision that allows real estate investors to deduct a significant portion of the purchase price of eligible assets in the year they are put into service.
- How does the phase-out of bonus depreciation affect real estate investors?
- The phase-out of bonus depreciation will reduce the immediate tax savings for real estate investors, potentially affecting cash flow and return on investment calculations.
- What is the role of cost segregation in real estate investing?
- Cost segregation is a tax strategy that involves identifying and separating personal property assets and land improvements from real property assets to accelerate depreciation deductions.
- How does the phase-out of bonus depreciation impact cost segregation strategies?
- With the reduction of bonus depreciation, the benefits of cost segregation may be less pronounced. However, cost segregation will continue to be a valuable strategy for real estate investors.
- How can real estate investors navigate the phase-out of bonus depreciation?
- Real estate investors can navigate the phase-out of bonus depreciation by working with experienced professionals who can provide guidance and support to ensure their investments remain tax-efficient.
