TABLE OF CONTENTS

    Understanding the concept of bonus depreciation and its practical application can help you capitalize on this opportunity and determine if investing in real estate now is a good time. So, what is bonus depreciation, and how does it affect you as an investor? Keep reading to learn more about bonus depreciation and how it works. 

    KEY TAKEAWAYS

    • Bonus depreciation allows businesses and investors to deduct a larger portion of qualifying asset costs in the year they’re placed in service, accelerating tax savings upfront. 
    • This deduction only applies to tangible personal property, certain improvements to real estate, and business assets with a useful life of 20 years or less. 
    • The percentage you can deduct depends on the year, as 100% bonus depreciation was phased out in 2022. 
    • The House recently passed legislation that may reintroduce 100% bonus depreciation, offering potential tax benefits for real estate investors.

    What Is Bonus Depreciation?

    Bonus depreciation was a key provision of the Tax Cuts and Jobs Act (TCJA) that enhanced bonus depreciation for qualified property or assets placed into service. 

    Bonus depreciation, also known as the special depreciation allowance, is a tax benefit that lets businesses deduct a large portion of the cost of qualifying new or used assets in the year they’re placed in service rather than depreciating them over several years. This accelerates the depreciation deduction, providing businesses with significant tax savings upfront. 

    Unfortunately, bonus depreciation was set to ramp down, with businesses only being able to deduct 80% in 2023. Bonus depreciation in 2024 allows businesses to deduct 60%, continuing to fall by 20% until 2026. 

    However, the recent legislative move to extend bonus depreciation through the Tax Relief for American Families and Workers Act of 2024 means that businesses may soon benefit from this 100% bonus depreciation once again, allowing them to write off a larger portion of their asset costs in the year of purchase, as long as the senate passes the bill.

    This extension allows real estate investors to reduce their taxable income and improve their cash flow through accelerated depreciation deductions. 

    Section 179 vs. Bonus Depreciation in Real Estate

    Like bonus depreciation, Section 179 of the U.S. Internal Revenue Code (IRC) offers an immediate expense deduction for business owners purchasing depreciable business assets. Unlike standard depreciation, which spreads the deduction over time, Section 179 allows businesses to deduct up to the full purchase price of qualifying assets in the year they’re placed in service. 

    This immediate deduction reduces the current-year tax liability, providing tax relief for businesses. However, Section 179 has limitations. For instance, the asset must be used more than 50% of the time for business purposes to qualify. There are also yearly limits placed on how much you can deduct. 

    On the other hand, bonus depreciation allows for immediate deductions but is not limited to specific assets. It generally allows you to deduct a certain percentage of the cost of qualifying assets placed in service in the year of purchase. Currently, the percentage you can deduct depends on the year. 

    The special depreciation allowance has no annual limit and can be larger than your income. 

    Bonus depreciation is often used for shorter-lived assets or improvements to real estate, such as new roofs or heating systems.

    How Does Bonus Depreciation Work?

    Bonus depreciation typically applies to tangible personal property, such as machinery, equipment, furniture, and vehicles, as well as certain qualified improvement property and specific types of real property improvements. These assets must have a useful life of 20 years or less. 

    Under bonus depreciation rules, businesses can deduct a specified percentage of the cost of qualifying assets in the year they’re placed in service. Again, the bonus depreciation for 2024 is 60%. As of right now, you can’t deduct the entire cost of the asset upfront. 

    Under current tax laws, bonus depreciation is available for assets placed in service before January 2027. However, the percentage will vary depending on the year. For instance, it’s set to be 40% next year if legislation bringing back 100% bonus depreciation doesn’t pass. 

    Unlike Section 179, which has specific dollar limits on the amount of deduction allowed, bonus depreciation doesn’t have restrictions. This means there’s no maximum limit on the deduction amount, allowing businesses to deduct the full cost of qualifying assets regardless of their value. 

    By taking advantage of the bonus depreciation, businesses can significantly reduce their taxable income for the year in which assets are placed in service. This can lead to substantial savings and improved cash flow, as businesses can retain more of their earnings to reinvest in their operations or other opportunities. 

    Additionally, if the bonus depreciation deduction exceeds the business’s taxable income for the year, the excess amount can be carried over to the next year to offset future taxable income. This offers flexibility for businesses with fluctuating income levels or those that cannot fully use the entire deduction in a single year. 

    What Assets Qualify for 100% Bonus Depreciation

    After its inception under the Tax Cuts and Jobs Act, the 100% bonus depreciation provision was phased out after 2022. Despite this, there are still significant benefits to be claimed for this year and beyond, especially if the 100% bonus depreciation benefit is brought back. 

    State tax treatment of federal expensing and bonus depreciation varies widely due to differing approaches to conformity with the Internal Revenue Code. States like Colorado, Kansas, and Louisiana conform to the current IRC, allowing for the full deduction, while others like Illinois, New Jersey, and Pennsylvania have decoupled from these provisions. 

    Additionally, bonus depreciation applies to certain business assets with a maximum useful life of 20 years, meeting specific qualifications. The taxpayer must not have used assets before acquisition, they cannot have acquired the asset from a related party, and a member of a controlled group of corporations cannot have owned the asset. Examples of qualifying bonus depreciation business assets include: 

    • Private Jet / Aircraft used for business purposes.
    • Short-term rental properties that are Modified Accelerated Cost Recovery System (MACRS) qualified or fall under the Qualified Leasehold Improvement Property classification.
    • Residential investment properties that have been cost-segregated.

    Two people shake hands next to a table upon which is a laptop, several documents with graphics, a stack of money, and a calculator.

    Certain assets are explicitly disqualified, such as those used in furnishing or selling utilities and those used in trades involving gas or steam distribution. Additionally, qualified improvement property acquired after December 31, 2017, is ineligible for bonus depreciation. 

    For bonus depreciation in real estate, it’s important for investors to understand that residential properties themselves don’t qualify for bonus depreciation because they have a longer useful life than 20 years. So, whether you have a DSCR loan or want to refinance your investment property, it doesn’t matter. What matters is the type of asset and its useful life. 

    While you can’t use the bonus depreciation deduction on residential property unless you administer a cost-segregation study, there are assets investors can claim bonus depreciation on. 

    Tangible property purchased for business use, including within rental properties, is deductible through the bonus depreciation for real estate. This applies to both new and newly acquired used property, provided it hasn’t been used personally before being placed in the rental. In other words, 100% bonus depreciation provides real estate investors an incentive to invest in improving and upgrading their property. These items might include: 

    • Appliances
    • Furniture
    • Lighting fixtures
    • HVAC systems
    • Televisions
    • Window treatments
    • Smart home technology

    Business operation assets also qualify, such as

    • Hardware and computers
    • Vehicles used for business purposes
    • Production equipment for filming, staging, and marketing properties
    • Office furniture and fixtures
    • Non-licensed software

    There are even eligible land improvements, such as

    • Landscaping
    • Irritation systems
    • Fences and walls
    • Sidewalks
    • Outdoor lighting
    • Security systems

    Keep in mind that land improvements must adhere to the 20-year useful life rule to qualify for bonus depreciation. 

    Pros and Cons of Bonus Depreciation

    Bonus depreciation offers significant benefits for real estate investors and business owners. However, there are potential drawbacks to consider. 

    Pros of taking the bonus depreciation deduction include: 

    • Immediate tax deductions: Using bonus depreciation allows investors to deduct a significant portion of their property’s costs in the first year, reducing taxable income and potentially lowering their tax liability. 
    • Accelerated returns: By front-loading deductions, inventors can enjoy higher deductions upfront, allowing them to generate profits sooner and reinvest resources into expanding their real estate portfolio
    • Flexibility: Bonus depreciation offers flexibility in managing taxes and cash flow, especially for those with fluctuating income or substantial capital expenditures. 
    • Net operating loss (NOL) creation: Claiming bonus depreciation in a year with losses can create or increase a net operating loss, which can be carried forward to offset future taxable income. 

    Potential disadvantages of using bonus depreciation include: 

    • Depreciation recapture: Upon selling the property, investors who claim bonus depreciation may be subject to depreciation recapture, requiring them to repay a portion of the deducted value. 
    • Can’t be used again: You can’t use the asset’s depreciation again in the future if you use bonus depreciation. Therefore, using bonus depreciation can lead to future tax challenges, particularly if a business experiences fluctuations in come or fails to anticipate future depreciation needs. 
    • Disparities in taxable income: For larger companies with significant capital expenses, bonus depreciation deductions may exceed current taxable income, resulting in unnecessary losses that may be difficult to manage. 

    Maximize Savings with 100% Bonus Depreciation

    While there’s currently no 100% bonus depreciation, recent legislative moves indicate the possibility of its reinstatement. This development presents a prime opportunity for investors to maximize their savings and optimize their tax strategies. By staying informed and monitoring the latest updates, you can position yourself to capitalize on the potential tax benefits of investing in real estate associated with bonus depreciation. 

    Considering investing in real estate? It’s always important to consider the tax implications by speaking to your tax professional. Partnering with a trusted mortgage lender like Griffin Funding can provide invaluable support. Whether you’re looking to secure an investment property loan for acquisitions or optimize your investment portfolio, we offer tailored solutions to meet your needs. Contact Griffin Funding today or download the Griffin Gold app to unlock the full potential of your real estate investments.

    Bill Lyons

    Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.