The 2017 Tax Cuts and Jobs Act (TCJA) was a sweeping legislation that rolled out numerous changes to the U.S. tax code with major impacts to individuals and corporations. Of the numerous changes, one of the most advantageous and by far my personal favorite was the enhanced benefits of Bonus Depreciation. Cool name, but what does it mean?
The “too long; didn’t read” version for those with a short attention span: IT MEANS YOU PAY LITTLE TO NO TAXES ON REAL ESTATE INVESTMENTS, BUT IT IS GOING AWAY SOON.
Obligatory Legal Disclosure: I am not a tax expert, nor do I claim to be. This article simply reflects my understanding of current real estate taxes, and you should always consult your tax attorney or professional before making tax-based decisions.
BACKGROUND
Since 2001, the U.S. has used bonus depreciation to incentivize business investment and growth. The intricate rules and processes have varied over the years, but the general theory and definition has remained the same. Bonus depreciation allows a taxpayer who invests in property that would generally be capitalized and depreciated over the useful life of that property to deduct all or a portion of the cost in the first year it is placed in service. Prior to the passage of the TCJA, bonus depreciation was set to phase out by the end of 2019 and was only available to new assets. To boil all this down into plain English: Prior to 2001 (pre-bonus depreciation) a property owner would divide the initial cost of the property by its useful life (27.5 years for residential, 39 years for commercial) and depreciate that value each year over the life of the asset. With bonus depreciation, if one purchased or built a NEW property, the value of the asset would be broken down into items with less than 20 years useful life and items with greater than 20 years useful life. The owner could then accelerate 40% of any items of the asset with a useful life of less than 20 years to be written off in year one of ownership, and the remaining items with over 20 years useful life would be divided by 27.5 and written off yearly for the remaining life of the asset.
MASSIVE CHANGES
The TCJA made a few significant changes to the bonus depreciation rules. The overhaul now allows taxpayers and business to deduct 100% of bonus eligible property in year one of ownership. Additionally, the benefit was updated to include new and used property, not just new property. Let’s take a look at some sample figures to illustrate how these seemingly minor changes actually have massive impacts to cash flows and project returns.
“Accelerating the depreciation to year one can result in massive increases to present value calculations for an asset.”
As you can see, accelerating the depreciation to year one can result in massive increases to present value calculations for an asset. I should note, when a property owner completes a cost segregation study, he or she is not creating more deductions. Instead the property owner is simply accelerating depreciation which would otherwise have been spread over 27.5 or 39 years depending on the property. Also, close attention should be paid to a taxpayer’s entire tax situation to determine if he or she should take advantage of bonus depreciation.
TAKE ADVANTAGE BEFORE ITS GONE
The massive benefits of 100% bonus depreciation will certainly not be around forever. In fact, the 2017 TCJA begins to phase down the bonus depreciation percentage for property placed in service between 2023 and 2026. This means there is a tight acquisition window to purchase property and take advantage of these lucrative changes to tax law before they possibly disappear forever. To learn more on Bonus Depreciation and how we use it to save our passive investors tens of thousands of dollars on their taxes, simply schedule a free discovery call and I would be happy to discuss it in detail.
