If you’re a property owner or investor, the answer could be yes. Bonus depreciation allows you to accelerate tax deductions, putting significant cash back in your pocket upfront rather than over decades. In this article, learn what bonus depreciation is, how it works, and why understanding it is vital for your real estate tax planning.
What Is Bonus Depreciation, and How Does It Work in Real Estate?
How Does Depreciation Work for Real Estate Investments?
Depreciation in real estate allows you to recover the cost of your investment over time. The IRS considers both residential rental property and commercial real estate as business assets subject to depreciation. For depreciation purposes, the IRS assigns specific useful life periods:
- 27.5 years for residential rental property.
- 39 years for commercial real estate.
With standard depreciation, you deduct a portion of the purchase price each year as a depreciation expense. For instance, a rental property worth $275,000 would allow you to deduct approximately $10,000 annually for residential real estate over 27.5 years. However, this approach can feel slow, especially for taxpayers looking to reduce their taxable income more quickly.
What Makes Bonus Depreciation Different?
Bonus depreciation is an accelerated depreciation deduction that allows businesses to deduct a significant portion of an asset's cost in the year it’s placed in service, instead of spreading it out over decades. Bonus depreciation provides immediate tax benefits, boosting cash flow and reducing taxable income upfront.
Under the Tax Cuts and Jobs Act (TCJA), bonus depreciation was increased to 100%, letting businesses immediately deduct the full cost of eligible assets. However, bonus depreciation percentages are now phasing out:
- 60% in 2024
- 40% in 2025
- 20% in 2026
Assets must have a useful life of 20 years or less to qualify for bonus depreciation. This includes personal property, land improvements, and some tangible property used for business purposes. Understanding the timeline is critical for real estate investors who want to take advantage of these deductions before the rules change.
Further Reading: Amortization vs. Depreciation
Which Assets Qualify for Bonus Depreciation in Real Estate?
Does Land or Land Improvements Qualify?
While real property like land isn’t eligible for bonus depreciation, certain land improvements can qualify. These improvements must have a useful life of 20 years or less and be considered tangible property under IRS guidelines. Examples of eligible improvements include:
- Fencing
- Parking lots
- Landscaping
- Outdoor lighting
These assets are often overlooked but can provide a significant bonus depreciation deduction when property management companies or real estate investors make updates to rental properties. Improvements must be placed in service during the tax year to qualify for deductions.
What Types of Personal Property Are Eligible?
Bonus depreciation applies to tangible property used in rental real estate or business operations. Eligible personal property includes:
- Appliances (e.g., refrigerators, stoves, or washers used in rental units).
- Carpeting and flooring.
- HVAC systems.
Both new and used property qualify for bonus depreciation, as long as you haven’t personally used the item before. Plus, property placed in service during the tax year must meet IRS standards to be considered qualified property. If you’re unsure about whether an asset qualifies, consult a tax expert to avoid missing valuable deductions.
Further Reading: Explore the significance of depreciation in financial statements
Maximizing Tax Benefits with Bonus Depreciation
How Can You Combine Bonus Depreciation with Section 179?
Combining bonus depreciation with a Section 179 deduction can be a powerful strategy to reduce taxable income. While both options allow businesses to deduct the cost of assets immediately, there are key differences:
- Section 179 lets you deduct specific business assets, like equipment or vehicles, up to a set limit ($1.16 million in 2024). However, Section 179 deductions are capped based on your total taxable income.
- Bonus depreciation has no limit and allows businesses to deduct a larger portion of the cost, even creating a net operating loss.
For real estate investors, this means you could use Section 179 for select property improvements and then apply bonus depreciation to eligible remaining assets. For example, a property manager could deduct the cost of HVAC systems with Section 179 and claim bonus depreciation on carpeting and appliances.
What Are the Risks and Rules for Bonus Depreciation?
While bonus depreciation provides substantial tax benefits, it may be subject to depreciation recapture if the property is sold. This means the IRS could tax some of the deductions you’ve claimed, so it’s essential to plan carefully if you intend to sell your property soon.
Taxpayers must comply with evolving bonus depreciation rules, including the phase-out schedule:
- In 2025, only 40% of qualified property costs can be deducted upfront.
- By 2027, bonus depreciation will be fully eliminated.
Ensure that all assets qualify under IRS guidelines, and keep detailed records of property placed in service to avoid compliance issues. Accurate bookkeeping is crucial for tracking depreciation deductions and staying ahead of potential audits. Using tools can simplify property management accounting, allowing you to focus on maximizing your tax benefits.
Further Reading: Learn how to calculate and understand rental property depreciation
Practical Steps to Qualify for Bonus Depreciation
How Do You Conduct a Cost Segregation Study?
If you want to use bonus depreciation for your real estate investment, a cost segregation study is essential. This process identifies depreciable assets within your property that qualify for accelerated deductions. Here’s how it works:
- Hire a Specialist: Work with a certified professional who understands special depreciation rules, as the IRS requires detailed compliance. A CPA or cost segregation expert will ensure your study meets U.S. tax standards.
- Break Down the Property: The study categorizes components like appliances, HVAC systems, and land improvements as qualified property placed in service with a useful life of 20 years or less. This is where bonus depreciation for qualified property comes into play.
- Report and File: The expert creates a detailed report, enabling you to claim deductions for eligible items and even calculate potential savings under declining balance depreciation methods.
For example, if your property includes land improvements such as fencing or parking lots, bonus depreciation allows businesses to deduct a percentage of the cost immediately instead of over decades. By identifying these items, you maximize your expense deductions and unlock the benefits of bonus depreciation.
What Records Do You Need to Maintain?
Claiming bonus depreciation often depends on meticulous recordkeeping. Without detailed documentation, you risk losing valuable deductions or facing IRS scrutiny. Here’s what you need to track:
- Purchase Documentation: Save invoices and receipts showing the asset’s cost and purchase date.
- Placement in Service: Record the date each depreciable item was placed in service, as depreciation deductions may only apply for the relevant tax year.
- Cost Segregation Study Report: Maintain the full breakdown of your property’s qualified property placed in service as identified by your professional.
Streamline Your Records:
Software simplifies this process by automating tracking for larger depreciation schedules and generating reports for tax filings. This ensures your deductions comply with bonus depreciation rules outlined under the Workers Act of 2024.
By staying organized and leveraging tools, you can confidently learn more about bonus depreciation while ensuring you capitalize on its full potential. Whether it’s understanding bonus depreciation vs. Section 179 or preparing for audits, proper bookkeeping gives you control over your finances.
Key Takeaways
- Bonus depreciation is often used to help real estate investors immediately depreciate assets with a useful life of 20 years or less, accelerating tax savings.
- A cost segregation study identifies the types of real property that qualify for bonus depreciation, such as land improvements and personal property.
- Section 179 allows businesses to deduct specific assets upfront, which can be combined with bonus depreciation for maximum benefits.
- Depreciation could phase out bonus depreciation percentages by 2027, dropping from 100% under the Tax Cuts and Jobs Act to 40% in 2025.
- The real estate industry benefits significantly from bonus depreciation, particularly for properties with eligible components like HVAC systems, carpeting, and fencing.
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