Tax savings are one of the many advantages of holding real estate assets in your portfolio.
Real estate investments function as small businesses, qualifying for deductions to offset revenue. In addition to subtracting business expenses, you can depreciate the asset (along with investments in capital improvements) to further reduce the tax bill.
Two central IRS codes relate to depreciation: Section 179 and Bonus Depreciation.
Each rule encourages businesses and investors to acquire and install capital equipment.
Section 179 allows companies to expense the total purchase price of qualifying equipment (and software) acquired during the tax year. Deductions begin to phase out between $1 million and $2.5 million with inflation adjustments.
As a permanent part of the US tax code, small and mid-sized businesses can deduct 100% of the acquisition costs for qualified equipment in year one to offset the cost of buying new equipment.
Since the passage of the JOBS Act in 2017, Bonus Depreciation has entered the picture, providing investors and businesses with an accelerated depreciation schedule for larger purchases.
Bonus depreciation can be taken in addition to the 179 depreciation allowance, applying to any remaining equipment exceeding its limits. When used, it substantially reduces taxes for businesses and investors.
What Purchases Qualify for Bonus Depreciation?
- New or used equipment provided the equipment is “new to you” or “first use.”
- Useful life of 20 years or less.
- Not purchased from a relative
- More than 50% of use is for business purposes.
- Includes both hardware and software assets.
- No annual limit
The Bonus Depreciation Schedule?
Bonus Depreciation and Multifamily Real Estate
Bonus depreciation can substantially reduce your tax bill in the first year of ownership.
While it does not apply to real property, you can conduct a cost segregation study that separates non-structural equipment that does qualify for the bonus depreciation.
For instance, the study might distinguish the cost of the HVAC system, sprinkler system, fences, and laundry equipment as non-structural equipment. It could also include qualified land improvements such as garages, pools, gyms, or playgrounds.
Now, instead of depreciating those assets over 5 to 39 years, you can accelerate the depreciation, giving you more tax benefits at the beginning of your ownership.
In 2023, the IRS allows you to take 80% of the benefit in year one, spreading the remainder 20% over 5, 7, or 15 years.
Using Bonus Depreciation to Offset K-1 Investment Income
Other key benefits of bonus depreciation is the ability to deduct it as a paper loss even if you earn a profit in year one.
The ability to reduce taxable income from any K-1 investment.
The IRS allows you to accept losses from passive income, regardless of the source. Therefore, you can offset gains from other passive income sources, not just the real estate asset attached to the bonus depreciation.
For example, if you earned $250,000 in passive activity income but received $100,000 in passive activity losses due to depreciation, you would only have = $150,000 in taxable passive income. Assuming a tax rate of 37%, you would save nearly $37k in taxes. That results in a return of around 18% just from the tax advantages!
The law applies to new and used assets, meaning that each year you invest in a new property, you can qualify for bonus depreciation on that asset.
In addition to the bonus depreciation, you also enjoy straight-line depreciation on the structural value of the property, providing ongoing benefits to real estate ownership.
If you want to learn more about how multifamily investing can reduce your taxable income, watch our introductory video.