Dave Barry once said, “We try to cooperate fully with the IRS, because, as Citizens, we feel a strong Patriotic duty to not go to jail.” This is your reminder that bonus depreciation is set to change again when the new year rolls over. We as real estate investors enjoy legally using the tax incentives that the US Government has put in place to do exactly what they wanted us to do: stimulate the economy by buying real estate.
However, the landscape is shifting once again, as bonus depreciation on real estate was reduced to 80% in 2023 and will fall further to 60% in 2024.
Understanding Bonus Depreciation
Bonus depreciation is a tax incentive designed to stimulate investment in qualified property, including real estate. It allows investors to accelerate the depreciation deductions on their property, effectively reducing their taxable income. This tax benefit was significantly enhanced by the Tax Cuts and Jobs Act (TCJA) in 2017, making it an attractive option for real estate investors.
Under the TCJA, bonus depreciation allowed investors to immediately deduct 100% of the cost of qualified property placed in service after September 27, 2017, and before January 1, 2023. This provided a substantial tax advantage for real estate investors, making it easier to offset rental income with depreciation deductions.
Ed was an investor client who each year from 2018 through 2022 bought multiple short-term rental properties and used the significant depreciation write-off to counteract other passive income from a small business he is a passive investor in. Now that Ed’s business is in slower growth mode, along with the reduction in bonus depreciation, Ed is shifting his focus to buying more stock at a discount. As he puts it, “It is important to remember that a good investor can pivot their strategy based on the market conditions.”
The Changes in Bonus Depreciation
The reduction of bonus depreciation on real estate to 80% in 2023, and further to 60% in 2024, comes as a result of legislative changes. In the years that follow, that percentage will drop by 20 points each year until bonus depreciation is completely phased out by 2027.
Implications for Real Estate Investors
Impact on investment strategies: Real estate investors may need to adjust their strategies in response to the reduction in bonus depreciation, including reevaluating the types of properties they invest in. Different assets benefit differently from cost segregation. For example, a garden apartment building with significant parking lot and landscaping falls into a shorter-life asset class eligible for greater bonus depreciation, while a mid-rise building with structured parking would see less benefit. Now may be the time to consider the higher-growth-potential asset.
Consider alternative tax benefits: Investors should explore other tax benefits available, such as credits for electric vehicle chargers, energy-efficient building improvements, solar installations, and Opportunity Zones.
Long-term planning: Investors should also consider the long-term impact of these changes. Depreciation is a deduction that gets recaptured at a 25% tax rate when a property is sold. However, for a property you plan to hold longer, the deduction now versus many years down the road is more valuable because of the time value of money and the effects of inflation.
Conclusion
This change underscores the importance of staying informed about evolving tax laws and adapting your investment strategy accordingly. Ed, for instance, is now employing other strategies, like using losses on cryptocurrency to offset the capital gains from selling a few of his short-term rental properties.
If you need to purchase before year-end to capture additional depreciation, or if you want to discuss how to pivot your strategy as you plan around your bonus depreciation timeline, we are happy to meet and share our perspective.
