Aligned Ventures
12/29/2022
Different investments come with their own distinct tax advantages. Over the past few years, real estate syndications have delivered numerous tax advantages that aren’t available with other investments. However, some of the best tax breaks you’ll have access to in a real estate syndication are set to phase out over time. In fact, 2022 is the final year that you can claim the 100% bonus depreciation. The following details what this tax break does for you and how you can claim it.
What Is Bonus Depreciation?
Investors have had access to bonus depreciation at differing amounts for many years. Before the Tax Cuts and Jobs Act of 2017 was passed, taxpayers had the ability to claim depreciation deductions that amounted to 50% of the total purchase price for a qualified property in the initial year after ownership. This type of deduction provides immediate savings when compared to the other form of depreciation that allows you to deduct small amounts over the life of the property.
2022 is the Final Year for 100% Bonus Depreciation
Once TCJA passed, the bonus depreciation deduction was expanded to 100% for the qualified property. However, this tax benefit only lasts until the end of 2022. In every year that follows, the depreciation amount drops by 20% until the benefit comes to an end in 2027. Keep in mind that Congress could extend this benefit in a future bill and has done so numerous times in the past. Even if they do, however, it’s unlikely that it would amount to 100% of the purchase price in the future.
It’s possible for a business to use this benefit by purchasing property with an expected lifespan of 20 years or less. The types of property that could apply include company vehicles, office furniture, computer systems, machinery, software, and equipment. Used and new property can qualify for bonus depreciation. In most cases, used property will qualify if it wasn’t:
- Used directly by the taxpayer before it was acquired
- Obtained from a related party
- Obtained via a tax-free transaction
Certain qualified improvement property can also make use of the bonus depreciation benefit. This property includes interior improvements that are made to nonresidential properties. While entire buildings can’t be used with bonus depreciation, there are components within buildings that could qualify. Any component of real property that’s actually deemed as personal property could qualify because of the shorter depreciation recovery periods.
Keep in mind that the property you want to claim the 100% bonus depreciation with must be placed in service before 2023. The IRS automatically applies bonus depreciation unless you choose to opt out for one of the other depreciation techniques. Bonus depreciation is set to decrease by the following amounts:
- Property that’s purchased and put in service after December 31, 2022 and before January 1, 2024: 80% of asset’s total cost
- Property that’s purchased and put in service after December 31, 2023 and before January 1, 2025: 60% of asset’s total cost
- Property that’s purchased and put in service after December 31, 2024 and before January 1, 2026: 40% of asset’s total cost
- Property that’s purchased and put in service after December 31, 2025 and before January 1, 2027: 20% of asset’s total cost
You should take some time to look at the various tax-saving strategies that can be employed for the 2022 tax year, which will give you a better idea if bonus depreciation is the ideal solution for your portfolio.
Estimated Recovery Timelines for Real Property
When the Tax Cuts and Jobs Act was passed in 2017, it maintained the recovery periods for real property that are listed in the Modified Accelerated Cost Recovery System (MACRS). This tax depreciation system states that nonresidential properties have a recovery period of 39 years. The recovery period for residential rental properties is 27.5 years. Both terms are longer than the 15-20 year limit available with bonus depreciation.
TCJA also got rid of multiple definitions for qualified restaurants, qualified retail improvement property, and qualified leasehold improvement. Now, a general recovery period of 15 years has been set for qualified improvement properties (QIP). Property under the alternative depreciation system (ADS) has a 20-year recovery period. QIP refers to improvements to the interiors of a nonresidential building. Keep in mind that elevators, internal structure framework, and enlargements are excluded.
How This Change Impacts Your Investment Portfolio
The rules regarding depreciation and current tax law change with each passing year, which can make it difficult to keep track of the decisions you need to make that will benefit your portfolio. Since the tax landscape shifts constantly, a strategy that works one year might not work the next.
If you want to take advantage of 100% bonus depreciation one last time, the property needs to be in place before the end of 2023. While the bonus depreciation benefit will continue to dwindle over the next few years, the advantages are still well worth it for the 2023 and 2024 tax years.
Even though entire properties don’t qualify for bonus depreciation, some of the improvements you make to your investment properties can qualify. You might also want to take quick action in regards to bonus depreciation because of the risks associated with rising interest rates, inflation, and the possibility of a recession. Now that you know what bonus depreciation is and why it matters for your portfolio, you can make a well-rounded decision.
