What is bonus depreciation, and how does it offset passive income?
Bonus Depreciation is a tax incentive put into place by Congress to speed up the depreciation of a property allowing taxpayers to immediately reduce their short-term taxable income by the cost of depreciable assets. Bonus depreciation is also referred to as accelerated depreciation or special allowance.
The Tax Cuts and Jobs Act was instated in 2017 and will remain effective through 2026. This was a part of an economic stimulus plan, to help encourage business investments through tax incentives for investors offsetting passive income.
How to Maximize Bonus Depreciation
Viking Capital has a cost segregation study done on all new acquisitions so our investors can seamlessly use bonus depreciation to their advantage. As the sponsor Viking Capital takes on all costs for the study, while still passing through the tax benefits to our investors.
Our acquisitions team vets hundreds of deals to find which offer the most upside as well as the greatest chance of bonus depreciation to capitalize on this fleeting opportunity. Our goal is to offer our investors investments that benefit them both in their short and long-term financial plans.
What is a Cost Segregation Study–
An analysis of the property components is categorized into those that can be depreciated more quickly than the standard depreciation timeline of 27.5 years. This creates tax benefits with a timeline of depreciation in 5, 7, or 15 years. These cost segregation studies vary from property to property but the goal is to determine what level of natural depreciation will occur on a property.
How long will Bonus Depreciation be in effect?
The bonus depreciation deduction, which has been a significant tax benefit, is on the verge of phasing out. The Tax Cut and Jobs Act introduced substantial changes to bonus depreciation rules back in 2017. However, these provisions have been reduced from the 100% depreciation rate to 80% as of January 2023, then will further decrease to 60% in 2024, 40% in 2025, and finally, 20% in 2026. Subsequently, the tax laws, including bonus depreciation, will revert to their pre-TCJA regulations.
Given this impending change, it’s crucial to make the most of the current 80% depreciation rate while it’s still available. Businesses can utilize IRS Form 4562 to document bonus depreciation, along with other forms of depreciation and amortization. Leveraging this deduction during the applicable period could make a significant difference in saving on equipment costs or property improvements.
Below is the expected timeline before bonus depreciation is no longer in effect in the U.S.
Bonus Depreciation Investment Example:
Your investment = $50,00 into a deal that closes by the end of 2022, you receive a K-1 reflecting a passive loss of $40,000 (which in this case represents 100% bonus depreciation).
If you were to invest in that same deal in 2023, the K-1 you would receive in 2024 would only show 80% of that $40,000. In other words, you would have a passive loss of $32,000 rather than $40,000.
Let’s take a look at what the implications would be in each subsequent year, assuming we’re talking about the same deal with the same cost segregation/depreciation potential.
- 2022 – 100% bonus depreciation = $40,000 passive loss
- 2023 – 80% bonus depreciation = $32,000 passive loss
- 2024 – 60% bonus depreciation = $24,000 passive loss
- 2025 – 40% bonus depreciation = $16,000 passive loss
- 2026 – 20% bonus depreciation = $8,000 passive loss
That means, for the same investment amount in the same deal, your passive loss for your 2026 taxes would be a mere fraction of the depreciation for that same investment, as applied to your 2022 taxes. You can clearly see why bonus depreciation is so advantageous and can provide a substantial benefit to your financial growth.
FAQs from Our Investors:
What income can be considered passive?
A) It is always best to consult a certified public accountant for any advice on income tax rules.
B) Any income made without your direct involvement in the operations can be considered passive. Unfortunately, dividends from stocks are not included, but real estate investments and K1 business ownership where you don’t materially participate are two of the most common income write-offs.
What’s the difference between bonus depreciation and depreciation?
A) Depreciation is a tax benefit that allows you to write off the value of an asset over time (27.5 years) based on the wear and tear over the useful life.
- Useful life refers to the time they anticipate a property being habitable.
B) Bonus Depreciation or Accelerated Depreciation is a limited tax resource that allows owners to write off segmented portions of the asset such as A/C units, washers, dryers, etc. on a shorter term (5, 7, or 15 years) offering stronger tax incentives.
What is the step-down calendar?
The Jobs and Care Act, allowing for 100% bonus depreciation is scheduled to end and reduces the percentage by 20% each year until 0% bonus depreciation will be offered in 2027.
How is bonus depreciation calculated?
The sponsor will hire a cost segregation analyst to go on-site and detail the parts of the property that can be depreciated and at what rates. Once they conclude their findings, they accelerate all depreciation that can be included in bonus depreciation and is passed on to the limited partners.
Does bonus depreciation expire or carry forward?
Bonus depreciation carries forward indefinitely and can be used when you have the passive income to offset. This happens during recapture even if you don’t use the bonus depreciation it will offset the revenue from the passive investment.
As this program is expected to phase out after 2026, Viking Capital is focused on taking full advantage of it while it’s available. Visit our website to view our open deals and find your next Multifamily investment. https://vikingcapllc.com
