A Quick Example Of 50% Versus
100% Bonus Depreciation
Let’s walk through a quick example so you can better understand the full impact of this increased bonus depreciation. Let’s say that we buy a commercial multifamily property before the end of 2022, for $60,000,000.
If we take the straight-line approach to depreciation, that means we can depreciate the cost of the building in equal portions (i.e., in a straight line) over 39 years, which is the depreciation schedule for commercial properties.
However, through the power of cost segregation, we can show that certain elements within the property (let’s say, the flooring, light fixtures, etc.) can be depreciated over a shorter lifespan. Let’s say those additional elements that qualify for accelerated depreciation come out to 25% of the cost of the asset, or $15,000,000.
With 100% bonus depreciation, that means that 100% of that amount (the full $15 million in this example) can be deducted in that same tax year when the property is acquired and placed in service. The remaining $45 million would then be deducted in smaller increments over the life of the asset.
Now here’s where the magic comes in for you as a passive investor (which, remember – as a passive investor, you get your portion of the pass-through tax benefits, including the bonus depreciation).
Let’s say that the total equity needed for the property is $18,500,000 (this includes the down payment, plus reserves and any additional funds for the intended business plan).
If the cost segregation can show that $15 million of the overall asset qualifies for accelerated depreciation in that first year, that means that the total depreciation amount would be roughly 80%.
If you were to invest $100,000 into that syndication, then you would receive a K-1 showing a paper loss of roughly $80,000, given the current allowance of 100% bonus depreciation.
Paper Loss In This Example, At 100% Bonus Depreciation
If that bonus depreciation were to drop to, say 50%, then the paper loss you’d see would only be around $40,000.
Paper Loss In This Example, At 50% Bonus Depreciation
This is particularly relevant if you have significant passive activity income (from real estate investments, businesses, or otherwise), and/or you qualify for REPS (real estate professional status)
, in which case your passive losses could apply to other types of income as well.
Again, check with your CPA on the direct implications for you and your tax situation.
But regardless of the exact implications for your tax bracket or tax situation, the point stands that greater depreciation now or in the near-term is generally better and more desirable.
Why? Because of the time advantage and opportunity cost.
If you can pay less in taxes now (even if that depreciation is recaptured later, upon sale of the asset), that gives you additional time to invest and grow the money you would have otherwise paid toward your tax bill.
This is why it’s imperative that you take advantage of the 100% bonus depreciation while it’s still available. Which brings us to our next topic – the phasing out of TCJA in the coming years and what that means for you.
The Timeline For Phasing Out 100% Bonus Depreciation
All good things must come to an end, and so it must be with 100% bonus depreciation as well. Sigh.
Currently, as of this writing, we are in the last calendar year in which you will be able to take advantage of the 100% bonus depreciation benefit as laid out by the TCJA.
The 100% bonus depreciation is set to phase out on the following schedule:
- 2018 to 2022 – 100% bonus depreciation
- 2023 – 80% bonus depreciation
- 2024 – 60% bonus depreciation
- 2025 – 40% bonus depreciation
- 2026 – 20% bonus depreciation
In other words, for commercial real estate syndication investments you make by December 31, 2022, those investments are still eligible for that 100% bonus depreciation.
Keep in mind though, that if you make an investment on December 31, 2022, but the deal doesn’t actually close until January 2023, then that investment would fall under the 80% bonus depreciation guidelines for 2023.
Thus, it’s risky to continue to wait for opportunities that may or may not come later this year, particularly if they don’t close by the end of this calendar year.
What this gradual phasing out means for you as an investor is that, with each passing year, as the bonus depreciation continues to decline, your tax bill may climb, which means it’s to your advantage to invest now rather than years from now.
On top of that, President Biden’s proposed Tax Act
, if passed, could eliminate the bonus depreciation altogether, and potentially much sooner than 2026. All the more reason to invest sooner rather than later.
Bonus Depreciation Example Scenarios
Let’s say you were to invest $100,000 in a deal that closes by the end of 2022, and that in 2023, you receive a K-1 that shows a paper loss of $80,000 (which in this case represents 100% bonus depreciation).
If you were to invest in that same asset in 2023, the K-1 you would receive in 2024 would only show 80% of that $80,000. In other words, you would have a paper loss of $64,000 rather than $80,000.
Let’s play this out further and see what the implications would be in each subsequent year, assuming we’re talking about the same asset with the same cost segregation / depreciation potential.
- 2022 – 100% bonus depreciation = $80,000 paper loss (in this example)
- 2023 – 80% bonus depreciation = $64,000 paper loss
- 2024 – 60% bonus depreciation = $48,000 paper loss
- 2025 – 40% bonus depreciation = $32,000 paper loss
- 2026 – 20% bonus depreciation = $16,000 paper loss
That means that, for the same investment amount in the same asset, your paper loss for your 2026 taxes would be a mere fraction of the depreciation for that same asset, as applied to your 2022 taxes. In this example, the depreciation would be $64,000 lower in 2026 than in 2022.
If your tax situation is such that you could apply those passive losses to other streams of passive (or even active) income, that decline in bonus depreciation would mean a substantial shift to your overall tax picture.
And even if you are only able to apply those passive losses to your passive income in that asset directly, that lower bonus depreciation means you’ll have less depreciation to carry forward for subsequent years, meaning your overall tax liability could be higher.
Again, please please please double and triple check everything with your own CPA to verify how all of this would apply to your unique tax situation.