Attention property investors! Significant tax changes are on the horizon for 2025, especially concerning bonus depreciation, a valuable tax-saving opportunity for real estate owners. The current rate will drop from 60% in 2024 to 40% in 2025. Here’s what you need to know to strategize effectively and maximize your investment returns before this shift.
What is Bonus Depreciation?
If you haven’t tapped into bonus depreciation yet, now’s the time. Bonus depreciation allows property investors to immediately write off a substantial portion of an asset’s cost in the year it’s put into service. This year, you can write off 60% of eligible property costs right away, resulting in significant tax savings and freeing up cash flow.
However, with the rate dropping to 40% in 2025, the upfront savings will decrease, reducing the immediate tax advantage for new property acquisitions starting next year.
Why Act Now?
Maximize Your Tax Savings: Consider finalizing any planned property purchases before year-end 2024 to take advantage of the higher 60% rate.
Reassess Financial Projections: With the reduced deduction in 2025, revisiting your financial plans and return expectations is essential. This adjustment can help align your strategies with the evolving tax landscape.
Get Professional Advice: Consult with a tax advisor to explore ways to optimize your tax planning. I can refer you to experienced professionals if needed.
Consider Cost Segregation Studies: Cost segregation (see below) can amplify your depreciation deductions by accelerating the depreciation of certain property components. If you’re unfamiliar with this, I’d be happy to provide insights.
Monitor the Market: The scheduled decrease in bonus depreciation may impact property values and market demand as investors adjust. Stay informed about market trends to gauge any potential shifts.
What Can Bonus Depreciation Be Applied To?
Bonus depreciation applies to a variety of assets, especially those that aren’t classified as part of the main structural building. Here are some common examples that often qualify for bonus depreciation in real estate investments:
Interior Elements:
- Flooring: Carpet, vinyl, and other easily replaceable floor coverings.
- Appliances: Refrigerators, dishwashers, washers, dryers, and other property-installed appliances.
- Furniture: Furnishings like desks, chairs, cabinets, and shelving.
Electrical and Plumbing Components:
- Specialized Wiring: Electrical work for dedicated equipment, such as separate wiring for appliances.
- Plumbing for Fixtures: Bathroom and kitchen-specific plumbing not part of the building’s core.
Landscaping and Site Improvements:
- Outdoor Lighting: Exterior lighting for pathways, parking lots, and security.
- Landscaping: Trees, shrubs, sod, and other decorative landscaping elements.
- Parking Areas and Walkways: Pavement, curbing, and exterior sidewalks.
- Fencing and Retaining Walls: Perimeter fencing, retaining walls, and similar elements.
HVAC and Specialized Systems:
- HVAC Units (Non-Structural): Some localized heating, ventilation, and air conditioning units that serve specific areas.
- Specialized Climate Control Systems: Units for specific rooms, such as wine cellars or server rooms.
Signage and Fixtures:
- Building Signage: Permanent but non-structural signs or branding installed on the property.
- Decorative Fixtures: Light fixtures, window coverings, and similar items designed to enhance aesthetic appeal.
Other Short-Life Property:
- Office Equipment: Items like computers, printers, and networking equipment if part of a rental property’s operational needs.
- Storage Units: Shelving, cabinets, and movable partitions in multi-use or commercial rental spaces.
These assets qualify because they can be separated from the core structure and often have shorter lifespans under IRS guidelines, allowing investors to benefit from accelerated deductions with bonus depreciation.
What is Cost Segregation?
From a real estate investor’s perspective, cost segregation is a tax strategy that breaks down or “segregates” the components of a property into different categories based on their useful life. This strategy allows you to accelerate depreciation and increase cash flow by reallocating certain portions of the property into shorter depreciation schedules, typically 5, 7, or 15 years instead of the standard 27.5 or 39 years for residential or commercial real estate, respectively.
Here’s how it works and why it matters for an investor:
Component Breakdown: A cost segregation study divides a property’s components into categories. For instance, electrical systems, plumbing, fixtures, carpeting, and even certain landscaping elements can be separated from the core building structure. These assets have shorter lifespans under IRS rules, allowing faster write-offs.
Accelerated Depreciation: By categorizing parts of the property under shorter lifespans, investors can depreciate more of the property’s value in the early years of ownership. This leads to a larger deduction upfront, reducing taxable income and freeing up cash for reinvestment or other expenses.
Bonus Depreciation: With bonus depreciation available (like 60% for 2024 and 40% for 2025), cost segregation becomes even more powerful. When assets are separated into shorter schedules, they often qualify for bonus depreciation, meaning an investor can immediately write off a portion of the reclassified property components in the year they’re placed in service.
Increased Cash Flow: With greater tax deductions early on, investors have more cash available in the initial years of ownership. This cash can be used to improve the property, reinvest, or even purchase additional assets, enhancing an investor’s ability to grow their portfolio.
By leveraging cost segregation, real estate investors can unlock tax benefits sooner, creating more efficient capital use and a stronger return on investment.
Cost Segregation vs Bonus Depreciation
Cost segregation and bonus depreciation are both powerful tax strategies in real estate, but they serve different purposes and work in tandem to maximize tax benefits for property owners.
Bonus Depreciation
Bonus depreciation is an additional tax benefit that allows a taxpayer to immediately deduct a large percentage of the cost of certain assets in the first year they are placed in service. This is particularly valuable after the Tax Cuts and Jobs Act of 2017, which increased bonus depreciation to 100% through the end of 2022. After that, the bonus depreciation percentage began phasing down (80% in 2023, 60% in 2024, and so forth).
Unlike cost segregation, which spreads out deductions across different asset lifespans, bonus depreciation applies a large, upfront deduction. Bonus depreciation typically applies to assets with a useful life of 20 years or less, so cost-segregated assets (those categorized for 5, 7, or 15-year depreciation) usually qualify for bonus depreciation, allowing a combination of both strategies.
Cost Segregation
Cost segregation is a tax planning tool that involves breaking down the components of a property into various asset categories. Instead of depreciating the entire property over a standard 27.5 years (for residential real estate) or 39 years (for commercial real estate), cost segregation identifies certain components, such as fixtures, electrical work, or flooring, that can be depreciated over shorter lifespans, like 5, 7, or 15 years.
This process accelerates depreciation, meaning you can write off a larger portion of the property’s cost in the earlier years of ownership, increasing cash flow and reducing tax liability in those initial years.
Combining Cost Segregation and Bonus Depreciation
Using cost segregation to identify shorter-lived assets and then applying bonus depreciation allows investors to maximize their deductions upfront. Essentially:
- Cost segregation determines which property components can be depreciated over shorter periods.
- Bonus depreciation allows for a substantial deduction of those identified short-lived assets in the first year they are placed in service.
In summary:
- Cost Segregation breaks down a property into components with varying depreciation schedules.
- Bonus Depreciation applies an immediate, large deduction to eligible assets, including those identified through cost segregation.
Together, they help accelerate tax savings, especially beneficial for real estate investors looking to improve cash flow early on.
Key Milestones for Bonus Depreciation Rates
- 2023: 80% bonus depreciation
2024: Reduced to 60% - 2025: Reduced further to 40%
What Happens After 2025?
The current bonus depreciation benefits were implemented under the Tax Cuts and Jobs Act (TCJA) in 2017 and are set to expire after 2025 unless extended. If the TCJA sunsets as scheduled:
2026 and Beyond: Bonus depreciation reverts to 0% for most new and used properties. Investors will need to rely on traditional depreciation methods, which spread deductions over the asset’s useful life.
Impact on Planning: The loss of bonus depreciation means smaller, annual deductions instead of substantial upfront savings. Investors may need to pivot to other strategies like Section 179 deductions to maintain tax efficiency.
Conclusion
The gradual phase-out of bonus depreciation means that 2024 may be the last opportunity for property investors to fully capitalize on this provision. As tax policies evolve, staying informed and proactive is crucial. Consulting a tax professional is always a wise choice, and we’re here to help guide you through all of your investment property financing questions.
