Unlocking the Power of Bonus Depreciation in Real Estate Investing
If you’re a real estate investor, you’ve probably heard the term Bonus Depreciation being tossed around but what exactly is it, and how can it help you save on taxes while maximizing your real estate investment? In this post, we’ll break down the concept of Bonus Depreciation and explore how it can be a game-changer for investors, particularly those involved in short-term rental (STR) investments, creative finance deals, or with larger property portfolios. Understanding Bonus Depreciation is crucial, as it can significantly impact your financial strategy and give you immediate tax savings that boost your investment returns.
What is Bonus Depreciation?
Bonus Depreciation is a tax incentive that allows real estate investors to accelerate depreciation on qualifying property. In simpler terms, it allows you to write off a larger portion of your property’s value in the first few years of ownership instead of spreading the depreciation over the typical period of 27.5 years for residential properties or 39 years for commercial properties).
In the United States, the Tax Cuts and Jobs Act (TCJA), enacted in 2017, allowed for 100% bonus depreciation on qualified property placed into service between September 27, 2017, and December 31, 2022. This allowed investors to immediately deduct the cost of eligible property (typically, tangible personal property like appliances, furniture, or certain improvements) rather than depreciating it over multiple years. However, the bonus depreciation percentage is now gradually decreasing. In 2023, it was 80%, with a 20% reduction each subsequent year until it reaches 0% in 2027, barring any changes to the legislation.
How Bonus Depreciation Works in Real Estate
To illustrate how Bonus Depreciation works, let’s say you’ve just purchased a rental property. If the property includes items like appliances, flooring, and landscaping, you can take advantage of Bonus Depreciation by accelerating the depreciation on these items.
For example:
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Purchase price of property: $500,000
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Qualified personal property (appliances, flooring, etc.): $100,000
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Bonus Depreciation: 60% of $100,000 = $60,000
This means you can write off $60,000 of your personal property in the first year instead of taking standard depreciation deductions over several years. This accelerates your tax savings and helps you reduce your taxable income for the year.
How Bonus Depreciation Can Impact Your Taxes
One of the primary benefits of Bonus Depreciation is the immediate tax savings it provides. By accelerating depreciation, you’re able to reduce your taxable income significantly in the year the property is placed into service.
Let’s say you’ve just purchased a rental property for $600,000, and the qualified improvements amount to $100,000. With 60% Bonus Depreciation, you could potentially write off the entire $60,000 in one year, which reduces your taxable income and can result in a lower tax bill for that year. This is especially helpful for investors looking to offset income from other properties, capital gains, or other sources of income, thus lowering your overall tax liability.
The Changes to Bonus Depreciation Rates
While Bonus Depreciation was once 100%, the percentage has started to phase down as part of the TCJA schedule. Here’s what you can expect in upcoming years:
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2023: 80%
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2024: 60%
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2025: 40%
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2026: 20%
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2027 and beyond: 0%
This means that while Bonus Depreciation is still available, the benefits are gradually decreasing, which makes it even more important for investors to take advantage of it sooner rather than later. Of course, there is always a chance that laws around Bonus Depreciation could change and the rates could increase again, potentially even back to 100%.
Strategic Uses of Bonus Depreciation for Real Estate Investors
Here are some strategic ways to use Bonus Depreciation to your advantage:
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Renovations and Upgrades: If you’ve recently renovated or upgraded your property, you can take advantage of Bonus Depreciation on the improvements made. This can help recover some of the upfront costs of renovations by reducing your taxable income.
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Buy and Hold Strategy: For buy-and-hold investors, Bonus Depreciation provides an immediate tax benefit that can help you reinvest those savings into additional properties or improvements.
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Short-Term Rentals (STRs): If you’re involved in short-term rental properties, Bonus Depreciation can allow you to write off furnishings, appliances, and other eligible property in the first year, which is perfect for maximizing cash flow early on.
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Creative Financing Deals: If you’re using creative financing methods like Seller Financing or Subject To (Subto), you may be able to use Bonus Depreciation to offset other income, giving you more flexibility in structuring deals.
Bonus Depreciation versus Regular Depreciation: What’s the Difference?
While both Bonus Depreciation and regular depreciation allow you to deduct the cost of your property, the key difference lies in how quickly you can claim those deductions.
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Regular Depreciation: For residential properties, you typically spread out your depreciation deductions over 27.5 years, which can slow down your tax savings.
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Bonus Depreciation: Allows you to take a larger deduction in the first year of ownership, accelerating the tax benefits significantly.
This makes Bonus Depreciation a powerful tool for real estate investors looking to maximize their short-term cash flow.
Consulting with a Real Estate Expert for Tax Savings
Navigating Bonus Depreciation and other real estate tax strategies can be complex. As an experienced real estate agent, I can help you understand how to best utilize Bonus Depreciation for your specific investment goals and help you develop a strategy that maximizes your returns and minimizes your tax liability.
