- September 21, 2024
- Posted by: Gavtax
- Category: real estate investors
One of the most valuable tools for real estate investors in recent years has been bonus depreciation, which allows property owners to immediately deduct a significant portion of the cost of certain assets in the year they are placed in service. Introduced as part of the 2017 Tax Cuts and Jobs Act (TCJA), this provision has been especially beneficial for real estate investors, syndicators, and developers who rely on accelerated depreciation to reduce taxable income and increase cash flow.
However, the 100% bonus depreciation provision, which allowed full expensing of qualifying assets, is gradually phasing out, and 2024 marks an important year in this phase-out process. Understanding how these changes impact real estate investments is crucial for landlords, syndicators, flippers, and wholesalers alike. This article explores the details of the bonus depreciation phase-out, its effect on different real estate stakeholders, and strategies to navigate the new depreciation landscape.
Bonus depreciation allows businesses, including real estate investors, to deduct a large percentage of the cost of qualifying assets in the year the assets are placed into service, rather than depreciating the asset over its useful life. Under the TCJA, bonus depreciation was set at 100%, meaning investors could fully deduct the cost of new and used qualifying assets, providing a significant upfront tax benefit.
Qualifying assets include tangible property such as equipment, machinery, and certain property improvements like HVAC systems or roofing for non-residential properties. Bonus depreciation applies not only to real estate but to most types of business property that have a useful life of 20 years or less.
The 2024 Phase-Out: What Changes Are Coming?
The full 100% bonus depreciation benefit is scheduled to phase out over several years. While 2023 was the last year to claim 100% bonus depreciation, 2024 is the first year of a gradual reduction:
(a) In 2024, the bonus depreciation rate drops to 60%. This means real estate investors can only deduct 60% of the cost of qualifying assets in the first year, with the remaining 20% being depreciated over the asset’s useful life.
(b) This phase-out continues, with the deduction dropping to 40% in 2025, 20% in 2026, and 0% in 2027, before being completely eliminated for assets placed in service after 2027, barring any legislative changes.
For real estate investors who have relied on this accelerated deduction, the gradual reduction will mean higher taxable income in future years and the need to rethink tax strategies.
Landlords and Property Investors
Landlords and property investors who make significant capital improvements to their properties have benefited from bonus depreciation over the past few years. By expensing improvements upfront, they’ve been able to offset rental income and reduce their tax burdens. As the phase-out begins, landlords will still have access to a partial deduction, but the reduced percentage may slow down their ability to fully offset income.
For example, if a landlord installs a $100,000 HVAC system in a commercial building in 2024, they can only deduct $80,000 that year, compared to the full $100,000 they could have deducted in previous years. This reduction in the immediate deduction may reduce the cash flow benefit in the short term, although the remaining $20,000 will still be depreciated over the asset’s useful life.
Syndicators
Real estate syndicators often depend on bonus depreciation to deliver tax-efficient returns to investors. When syndicators acquire large properties, they frequently perform cost segregation studies to break down the property into various components (such as appliances, lighting, or flooring), allowing them to maximize depreciation benefits.
The reduction in bonus depreciation means syndicators may need to adjust their projections for investor returns. While the upfront tax savings are still substantial at 60%, the gradual reduction will impact how syndicators structure deals and communicate returns to their investor pool.
Flippers
For property flippers, bonus depreciation isn’t typically as critical because they generally focus on short-term property holds and improvements that don’t involve long-term capital expenditures. However, for flippers who invest in equipment or tools for renovation purposes, the phase-out will slightly affect how they expense these assets.
Wholesalers
Wholesalers, who primarily deal in assigning contracts rather than owning property, are largely unaffected by bonus depreciation changes. Since they don’t typically hold or improve properties, their tax strategies won’t be influenced by the depreciation phase-out.
Despite the reduction in bonus depreciation, there are strategies that real estate investors can use to continue maximizing their tax benefits in 2024 and beyond.
1. Accelerate Planned Improvements: If you’re considering making significant improvements to your properties, 2024 may be the right time to act before bonus depreciation drops further. By completing these improvements now, you can still take advantage of the 60% deduction, maximizing your tax savings in the short term. For example, landlords upgrading HVAC systems, installing new roofing, or making other substantial improvements should aim to place these assets in service during 2024 to benefit from the higher deduction rate.
2. Use Cost Segregation Studies: Cost segregation studies remain a valuable tool for syndicators and commercial property investors. Even as bonus depreciation phases out, these studies allow investors to accelerate depreciation on specific components of a property. This ensures that non-structural elements, such as lighting, flooring, and certain appliances, are still depreciated more quickly, creating substantial upfront tax savings even without 100% bonus depreciation.
3. Explore Other Depreciation Methods: As bonus depreciation becomes less generous, investors can look to other depreciation methods, such as Section 179 expensing. While Section 179 has its own limits and restrictions, it allows investors to expense certain assets, particularly business-related equipment and vehicles, immediately. Real estate investors should assess whether their purchases qualify under Section 179, as this can still provide immediate tax relief.
4. Consider Alternative Investment Strategies: With the bonus depreciation phase-out, some investors may shift their focus toward other tax-efficient investment strategies. Opportunity Zones, for example, allow investors to defer capital gains taxes while reinvesting in designated low-income areas, potentially providing tax-free appreciation after ten years.
The phase-out of 100% bonus depreciation marks a significant shift for real estate investors who have relied on the immediate tax deductions offered by this provision. While the 60% bonus depreciation rate still offers considerable tax relief in 2024, investors will need to adjust their strategies as the deduction continues to decrease in future years.
Landlords, syndicators, and developers should consider accelerating planned improvements, utilizing cost segregation studies, and exploring alternative tax-saving strategies to ensure that they continue to maximize their tax benefits. As always, working with a qualified tax advisor will be essential for navigating these changes and ensuring that your real estate investments remain as tax-efficient as possible.