Investor Alert: Bonus Depreciation Is Going Away… Here’s What You Can Do About It

Bonus depreciation, an advantageous tax incentive for investors, is undergoing significant changes that may affect your investment strategy. As part of the Tax Cuts and Jobs Act, bonus depreciation allowed investors to immediately deduct a percentage of the purchase price of eligible business assets. This was a substantial benefit for real estate investors, enabling them to deduct 100% of the cost of qualifying assets. However, with the phase-out period beginning, your tax planning for asset purchases must adapt accordingly. For the 2023 tax year, the deduction drops from 100% down to 80%, which alters the overall cost of your investments and the timing of your asset acquisitions.

Before we dive into the current legislation being considered by the Senate, let’s revisit what bonus depreciation is and why it matters to real estate investors.

What Is It?

Bonus depreciation is a tax incentive designed to stimulate business investment by allowing taxpayers to deduct a significant portion of the cost of eligible assets in the year they are placed into service. Historically, bonus depreciation was used to encourage businesses to invest in new equipment and machinery, but. In 2017,  it was expanded to include qualified improvement property (QIP) for real estate investors.

Bonus depreciation can significantly reduce your taxable income, enhancing your cash flow and reinvestment capacity. 

How Does It Work?

Bonus depreciation allows you, as a real estate investor, to deduct a substantial portion of the purchase price of qualifying assets in the year they are placed into service. Typically, when you purchase a property, the common practice is to depreciate the building over 27.5 years for residential properties and 39 years for commercial ones. For assets like appliances, which include refrigerators and HVAC systems, the standard depreciation period is shorter, generally around five to seven years. The IRS calls these timeframes the “recovery period,” and are based on estimates of how long it takes to recoup the cost of an asset.

However, with bonus depreciation, you can accelerate this process. Instead of spreading the deduction for the cost of the asset over many years, real estate investors can accelerate this tax benefit by recouping the entire deduction up front in the first year. This upfront deduction can significantly reduce your taxable income and increase your cash flow, allowing you to reinvest in other opportunities or pay off debt.

Why Is It Important to Real Estate Investors?

Bonus depreciation functions as a real estate investor tax credit. Essentially, it allows for a more rapid recovery of the costs associated with income-producing property through an immediate deduction of a significant portion of the purchase or improvement cost.

Here’s why this is crucial for you:

  • Cash flow boost: By utilizing bonus depreciation, you reduce your tax liability, thereby preserving cash on hand. This infusion of liquid capital can then be funneled back into your operations or potential new investments.
  • Cost recovery: The benefit lies in accelerating the depreciation schedule. Instead of spreading the depreciation of assets over longer periods, you can claim larger deductions early on.
  • Strategic planning: With the right approach, bonus depreciation forms a part of your strategic tax planning. This tax tool enables you to create a more efficient tax scenario, potentially deferring taxes and better managing your investment portfolio.

What Happens if It Goes Away?

When bonus depreciation decreases, you may need to rethink your investment strategy. In 2024, for example, you’re looking at a reduction to 60% bonus depreciation, which could alter the economics and dynamics of the deals you consider. Here’s how:

  • Acquisition Adjustments: With the decline, the initial assumptions underpinning your deals may need to be reevaluated. The cost-saving impact bonus depreciation currently offers will diminish, meaning some projects that seemed financially viable before may no longer pencil out.
  • Syndication Deal Appeal: As a prospective limited partner in syndication deals, the phasing out of bonus depreciation may dampen the attractiveness of such investments. Previously, the depreciation benefits were a significant draw, offering a tangible return on investment through tax savings.
  • Cash Flow Projections: Without the sizable deductions from bonus depreciation, your cash flow projections may need adjustments. The tax deductions have, until now, been a crucial element in enhancing the after-tax cash flow for investors.
  • Revised Financial Modeling: You’ll need to revise your financial models to reflect the reduced tax shield, which could impact your overall return metrics.

Stay informed and ready to adapt your strategies to navigate the changing tax benefits landscape.

Why Does It Matter?

Understanding the implications of bonus depreciation changes is crucial for your financial planning. The allowance for immediate write-offs on eligible business assets is set to decrease with further reductions in coming years. This modification has direct consequences for your tax liabilities and capital investment strategies.

Here’s the breakdown of the phase-out:

  • 2023: 80% bonus depreciation
  • 2024: 60% bonus depreciation
  • 2025: 40% bonus depreciation
  • 2026: 20% bonus depreciation
  • 2027: 0% bonus depreciation

Notably, there is potential for these terms to change. The House passed a bill extending 100% bonus depreciation through 2025, which, if approved by the Senate, will revise the depreciation benefits for 2023-2025. The anticipation around this proposed legislation highlights a window of opportunity that could alter your investment decisions and tax planning.

What Can You Do?

As investors navigate these changes, engaging with senators to support the passage of H.R.7024, “The Tax Relief for American Families and Workers Act of 2024,” is critical. This legislation is not only pivotal for maintaining the competitive edge of real estate investments but also for the broader economic contributions of the sector through housing revitalization and community development​​. Whether it’s through a phone call, email, or social media post, advocating for this bill can make a significant impact on the future of tax benefits for eligible business assets.

By understanding the nuances of bonus depreciation and its phase-out, you’ll be able to better navigate the changing tax environment, ensuring your investment strategies remain robust and responsive to legislative developments. For a deeper dive into this topic, listen to a recent podcast hosted by Jack BeVier, partner at Dominion Financial, and Craig Fuhr, loan officer at Dominion Financial, where tax attorney Doug Stein discusses the changes in tax law in 2024 related to real estate investing.

The above article was inspired by Episode 30 of Real Investor Radio, ‘Changes in Tax Law in 2024 Related to Real Estate Investing’ with guest host, Tax Attorney Doug Stein.

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