It is not a “doom and gloom” scenario for the real estate industry
The current state of 100% Bonus Depreciation did not come about until the Tax Cuts Jobs Act (TJCA) was signed in February of 2018. It should be noted, when bonus depreciation was offered in the past, it ONLY applied to new construction or newly constructed improvements. The TCJA opened this tax incentive up to acquired properties (or “used property” as named in the TCJA bill).
This allowance for bonus depreciation on “used” property significantly changed the real estate investment industry. And the tax benefits associated with it. Now some are stoking fear that it is going away at year end. And technically it is. But there is more to the story.
What is Bonus Depreciation really?
Before you can actually “elect” bonus depreciation…wait what?
That’s right, it’s an election on your tax return, it’s not automatic. In order to actually elect 100% bonus depreciation, you must first have a cost segregation study completed. This study reclassifies some of the 39 or 27.5 year straight-line components into a shorter life class of 5, 7, or 15 years.
These shorter life components are what qualify for Bonus Depreciation. These reclassified components are how you accelerate (or front load) your depreciation tax deductions. And by taking these additional tax deductions, you increase your cash flow.
So when you elect 100% bonus depreciation, this allows ALL the accelerated deductions to be taken in year one, versus over their shorter life. By definition, bonus depreciation does not increase or offer extra depreciation, it just allows “ALL” the shorter life depreciation to be taken in year one (or the current tax year). If you have excess or unused depreciation in the current tax year, it functions as a carry forward loss or suspended loss (NOL) to be used in future tax years.
So What is Happening to 100% Bonus Depreciation at yearend 2022?
The expiration of 100% bonus on 12/31/2022 may seem like a Y2K like event, or the end of the world to some. Believe me, it’s not. The sun sets on this tax incentive slowly at 20% per year starting in 2023.
The TCJA placed a phase out provision (or sunset clause) of 20% per year in bonus depreciation beginning in 2023. As such, bonus depreciation will be 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and then zero in 2027. All of which are beneficial to real estate investors. Admittedly 100% bonus is most beneficial.
It is very important to understand that even with bonus depreciation declining over the next 5 years, ‘accelerated depreciation’ will still be in effect. Meaning, your ability to accelerate depreciation to increase federal tax deductions on the same components that qualify for bonus depreciation is not going away. This is a IRS tax guideline.
“Cost Segregation is not a tax shelter. It is a specifically defined and guided I.R.S. tax reduction tool. Ninety percent (90%) of all commercial property investors are overpaying their federal income taxes.” The Journal of Accountancy
Our firm has provided cost segregation services for 20 years on more than 15,000 properties. And for fifteen of these years, 100% Bonus Depreciation did not exist as we know it now.
So, this is definitely not a “doom and gloom” scenario for the real estate industry. Sunsets can be beautiful. And if you are fortunate to be watching the sunset on a clear evening over the Gulf of Mexico, Pacific or other body of water, you may be rewarded with a green flash!