Congratulations on completing the journey of purchasing or renovating a property! Now that you’ve reached this milestone, it’s time to turn your attention to an essential aspect of real estate investment: taxes. Fortunately, real estate investors like you have access to a plethora of favorable IRS code sections to ease the tax burden. One particular favorite among savvy investors is the highly beneficial – bonus depreciation. In this blog, we’ll delve into the exciting realm of bonus depreciation and explore how it can be your ultimate ally in optimizing tax advantages and enhancing your overall real estate investment strategy. Let’s dive in and uncover the tax-saving potential that awaits you!
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows businesses to deduct a significant portion of the cost of qualifying assets immediately in the year of purchase, rather than spreading it out over several years through regular depreciation. It is a powerful incentive aimed at encouraging businesses to invest in capital assets and stimulate economic growth.
Key Features of Bonus Depreciation:
Increased Deduction: With the Tax Cuts and Job Act (TCJA) of 2017, bonus depreciation was increased to allow 100 percent deductions of qualified assets. As a result, businesses could deduct up to 100% of the cost of qualified assets in the year they were placed in service. This immediate deduction resulted in substantial tax savings and improved cash flow.
Beginning January 1, 2023, bonus depreciation will be capped at 80 percent and will begin to gradually phase down year over year by 20 percent until 2027 where bonus depreciation will be zero. This marks a significant shift in the tax landscape for businesses. This change comes as a result of recent tax reforms and is aimed at striking a balance between stimulating economic growth and fiscal responsibility. The phase-out schedule may vary depending on the type of qualified property, so it’s crucial for investors to stay updated on the latest regulations to make informed financial decisions.
While the phase-out of bonus depreciation may create some headwinds for businesses relying heavily on this tax incentive, it’s essential to keep in mind that standard depreciation methods are still in place. Regular depreciation deductions, although spread over a longer period, continue to provide tax relief for companies investing in capital assets. Additionally, other tax-saving strategies and incentives may be available to businesses to help mitigate the impact of the phase-out.
To navigate this changing tax landscape successfully, businesses should consult with their tax advisors to understand how the bonus depreciation phase-out will affect their specific situation. Long-term planning and careful consideration of investment decisions will be key in optimizing tax benefits and maintaining financial stability.
Qualifying Assets:
Bonus depreciation typically applies to tangible property, such as machinery, equipment, furniture, and qualified improvements. It is important to note that some assets, like HVACs and roofs, may not be eligible for bonus depreciation. In addition to bonus depreciation, there is always the option of 179 expensing available as well. However, for the scope of this article, we won’t delve into the details of that code section.
New and Used Assets:
In recent years, the tax laws have allowed bonus depreciation for both new and used qualified assets. This expansion opens up opportunities for businesses to acquire used equipment at a lower cost while still enjoying significant tax benefits.
Advantages of Bonus Depreciation:
- Immediate Tax Savings: By expensing a substantial portion of the asset’s cost upfront, businesses and investors can significantly reduce their taxable income for the year of purchase, thereby lowering their tax liability.
- Boosted Cash Flow: The tax savings generated through bonus depreciation can be used to buy or rehab your next property.
- Financial Planning: Bonus depreciation provides businesses with greater financial predictability, as they can accurately anticipate tax savings and cash flow benefits when planning for the future.
- Encourages Investment: The availability of bonus depreciation encourages businesses to invest in growth and modernization, contributing to economic development.
Limitations and Considerations:
- Temporary Provision: Bonus depreciation has historically been a temporary provision, and its availability may change depending on legislation and economic conditions, as we are seeing with the current and upcoming phase-out of bonus.
- Dispositions of Assets: If a business disposes of an asset on which bonus depreciation was claimed, certain recapture rules may apply, potentially resulting in additional taxes in the year of disposition.
Planning Ideas To Take Action Now:
- Cost Segregation Studies: Through a cost segregation study, a property’s assets are thoroughly analyzed, and certain components that would typically be depreciated over many years can be reclassified as shorter-lived assets. These shorter-lived assets are eligible for accelerated depreciation, allowing investors to claim more significant deductions upfront, which can result in substantial tax savings in the early years of property ownership. (To be discussed in further detail in another blog)
- Accelerate Improvements and Renovations: Do not wait to do those renovations.
- Stay Informed about Tax Laws: Keep up-to-date with the latest tax regulations and changes to optimize bonus depreciation benefits.
- Consult with a Tax Professional: Seek advice from a knowledgeable tax specialist with expertise in real estate and bonus depreciation strategies.
- Timing of Property Acquisitions and Disposals: Consider acquiring properties before the bonus depreciation phase-out period or plan for potential recapture upon property sale.
In conclusion, bonus depreciation offers a powerful incentive for real estate investors to boost cash flow and enhance overall returns. By exploring strategies like cost segregation studies, optimizing property improvements, staying updated on tax regulations, and carefully timing property transactions, investors can make the most of bonus depreciation opportunities and optimize their tax positions effectively. As with any tax-related matters, seeking advice from qualified professionals who specialize in real estate is always prudent to ensure compliance and achieve the best possible outcomes for rental property investments. Contact us at (954) 998-1190 or info@gratuscpa.com for more information.
