Summary: If you haven’t heard, bonus depreciation is being phased-out over the next several years! Whether you’re an experienced investor or a newbie, you’re going to want to know how this is going to impact you as a real estate investor. You might be wondering, does this mean it’s not worth doing a cost segregation study anymore? What about real estate investing in general? In this article we’ll answer these questions and more!
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
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If you’re a veteran real estate investor and you’ve sheltered W2 or 1099 income with Real Estate Professional Status or the Short-Term Rental Tax Loophole, you already know about the benefits of bonus depreciation.
Whether you’re a veteran or a newbie investor, you might not know that bonus depreciation is being phased out over the next four years.
If that’s news to you, you probably have a lot of questions:
What are the implications of the phase-out?
Does this mean it’s not worth doing a cost segregation study anymore?
What about real estate investing in general?
Without bonus depreciation, is it even worth investing in real estate anymore?
Key Takeaways of the Bonus Depreciation Phase-Out
Instead of making you wait until the end of the article to find out the answers, I’m going to start by summarizing the key takeaways:
- Starting in 2023, bonus depreciation will be phased-out over the next 4 years, and completely phased out by 2027.
- In 2023, bonus depreciation will drop to 80%. From there it will decrease by 20% each year until it is completely phased out.
- Even without bonus depreciation, you still have accelerated depreciation. The benefits of accelerated depreciation aren’t as far off from 100% bonus depreciation as you might think. We show you an example to illustrate the difference between 100% bonus depreciation and accelerated depreciation.
- For us, the phase-out doesn’t change our opinions about real estate investing. It continues to be a tremendous investment vehicle. It continues to be one of the best ways for high-income doctors and professionals to legally shelter their taxes.
- We anticipate the major impact of the phase-out will be that investors will hold onto their properties longer. The buy and hold strategy is actually where we started our journey. 100% bonus depreciation incentivized us to sell properties that we would have normally held onto for a longer period of time. With the phase-out, it’ll be back to business as usual!
OK with those key takeaways out of the way, let’s dive into the content. Check out the table below to see the difference between 100% bonus depreciation and the amount of depreciation you can claim as it’s being phased out. The results may surprise you!
What is Bonus Depreciation?
We’ve covered this in detail in a prior article but here’s a brief primer.
There are three types of depreciation: regular, accelerated, and bonus depreciation.
Regular straight-line depreciation is when the value of a property goes down to zero by the same amount each year over a period of time. For residential real estate, the life-time of a property is 27.5 years. You can see this illustrated in the table below in the column titled “without a CS (cost segregation) study.” The value of the property goes down by $29,091 each year.
Accelerated depreciation is when you depreciate components of the building at different depreciation schedules. So some components of the property like appliances won’t last 27.5 years. Instead, they might have a 5 year life-time. So this allows you to front-load a lot of the depreciation in the early years of ownership.
This is illustrated in the column of the table labeled “0% bonus.” As you can see, the numbers are a lot higher than what you get with regular depreciation.
Bonus depreciation is a turbo-charged version of accelerated depreciation where you can front-load the depreciation even more. With 100% bonus depreciation, you are depreciating everything with less than a 20 year life in the first year.
In the table below, you can see how the depreciation is front-loaded with 100% bonus compared to 80%, 60%, and so on.
Is Bonus Depreciation Being Phased Out?
100% bonus depreciation came about in 2017 with the Tax Cuts and Jobs Act (TCJA). The phase-out was part of this legislation.
Basically, this was always going to be a temporary benefit for real estate investors. This party wasn’t meant to last forever.
Starting in 2023, 100% bonus depreciation will drop to 80%. Then in 2024, bonus depreciation will go to 60%. From there, 40% in 2025, 20% in 2026, and 0% in 2027.
Is it Worth Doing a Cost Segregation Study After Bonus Depreciation is Phased Out?
This is a common question. In brief, the answer is YES!
To illustrate this point, we asked our go-to cost segregation provider, Kim Lochridge at Engineered Tax Services (click HERE if you want an intro) to create the following table illustrating the differences in depreciation as bonus depreciation is being phased-out.
As seen, assuming you hold the property for 5 years, the difference between 100% bonus depreciation and 0% bonus depreciation (accelerated depreciation) isn’t that significant ($314,789 vs $271,080).
You are still able to claim a large portion of the depreciation up front.
What Will Real Estate Investors do Differently as a Result?
It’s hard to predict how the bonus depreciation phase-out will change what investors do. However, our guess is that it won’t have as big of an impact as people think.
With or without bonus depreciation, the fundamentals of real estate investing are the same. It doesn’t affect your ability to generate a great cash-on-cash return or force appreciation. Above all, it’s still a great way to diversify your portfolio. It continues to be a great hedge against inflation.
I think for us, the greatest impact of the changes is a shift back to how we always invested. Which was using the buy and hold strategy.
All in all, we grow our wealth by buying cashflowing properties and holding these properties over the long term.
Now this doesn’t mean we don’t sell. Ultimately, we will continue to sell and 1031 exchange into larger properties. However, the main difference is that we’ll probably hold onto properties we buy a little longer.