Dave Barry 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 further down 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 2018-2022 has bought multiple Short Term Rental properties and used the significant Depreciation write-off to counteract his other passive income from a small business that 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 changing his focus to buying more stock at discount. He emphasized, “It is important to remember that a good investor can pivot their strategy based on the market conditions.”
The Changes to Bonus Depreciation
The reduction of bonus depreciation on real estate to 80% in 2023 and further down to 60% in 2024 comes as a result of legislative changes. In the years following, that percentage will reduce 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 investment strategies in response to the reduction in bonus depreciation. This could include reevaluating the types of properties they invest in.
Different assets may benefit from greater benefits of cost segregation. For example, a garden apartment building with significant parking lot and landscaping, versus a midrise building in the city with structured parking. The parking lot and landscaping falls into a short term life asset, which is eligible for bonus depreciation. In contrast, the mid-rise building would have less depreciation. - Consider Alternative Tax Benefits:
Investors should explore other tax benefits available, such as credits for electric vehicle chargers, energy efficient building improvements, solar, and Opportunity Zones. - Long Term Planning:
Investors should also consider the long-term impact of these changes. Depreciation is a deduction that is recaptured at 25% tax rate when a property is sold. However, for a property you plan to keep for a longer hold time, the deduction now versus many years down the road is more valuable because of the time value of money and inflation ravages.
Conclusion
This change underscored the importance of staying informed about evolving tax laws and regulations, and adapting investment strategies accordingly.
Ed is employing other strategies, like using his losses on crypto to offset the sale of a few of his Short Term Rental properties, which he sold with capital gains.
If you need to purchase before the end of the year to add depreciation, or if you want to discuss pivoting your strategy, we are happy to meet and share our perspective.
