By Robert Rahner, Cost Recovery Solutions LLC
In the world of cost segregation, 100% bonus depreciation has been the “cherry on top” tax tool from which many commercial property investors have been able to consistently benefit since the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. However, starting in 2023, the benefit that effectively allows owners to expense the full cost of qualifying capital assets in the year they were acquired (instead of in smaller amounts over the life of the property), is going to start fading to black over the next five years.
Background on “Bonus”
The concept of bonus depreciation was born in 2002 with the Job Creation and Worker Assistance Act, which was enacted to provide tax relief and incentives for companies to expand and create jobs by investing in new plants and equipment. Aside from a brief period at 100% in 2010 - 2011, the amount of bonus allowed typically ranged between 30% – 50% through subsequent acts targeted to keep the economy moving forward and spur new growth over the years. The TCJA expanded the benefit back up to 100% and allowed it to be taken on acquisitions instead of just new construction. It also extended the timeframe to include qualified assets placed into service between September 27, 2017 and January 1, 2023. Once the pandemic hit, using bonus depreciation was an effective tool for investors hit hard by the economic standstill to feel more confident in continuing to make investments in their properties.
However, unless Congress extends the incentive once again (which doesn’t sound likely), the bonus amount will start reducing next year by 20% annually until it completely expires by 2027. This means that the sooner an investor plans on purchasing property that qualifies for bonus depreciation, the better!
So What Qualifies for Bonus?
Generally, the rules for taking bonus depreciation include property that meets the following criteria:
• Is acquired for use in a business or other income producing activity.
• Is expected to last more than a year, with a useful life of 20 years or less (examples include computer systems, certain vehicles, machinery, equipment, and office furniture).
• Is new or, if used, was not used by the taxpayer or a predecessor before acquiring it, acquired from a related party or acquired as part of a tax-free transaction.
Investors and Qualified Improvement Property (QIP)
For real estate investors, most interior improvements made to nonresidential property (excluding structural framework/building expansion, escalators or elevators) can qualify for bonus depreciation. The CARES Act of 2020 retroactively corrected a drafting error made in the TCJA that originally excluded QIP, so now this can be claimed for property put into service in 2018, 2019 or 2020 as well.
How CRS Can Help
Determining which assets a real estate investor owns that can qualify for bonus depreciation is tricky. Buildings themselves do not, but cost segregation studies performed by experienced CRS engineers:
• Identify parts of commercial real estate properties that can actually be considered tangible personal property.
• Reallocate those assets to shorter depreciation schedules.
• Determine which interior building upgrades can qualify as QIP.
We can also calculate the tax savings you can gain (or lose) based on the year that you put a specific property into service. The table below demonstrates the diminishing tax saving benefits available for a $1M investment as bonus depreciation rates fall 20% over each of the next five years.
As you can see, the longer an investor waits to take advantage of bonus depreciation, the more their bottom line can be affected.
Other Options
While bonus depreciation is a powerful tool to consider, it may not always be the best tax strategy depending on an investor’s specific purchase and investment goals. Other options to consider include using Section 179 expensing, putting off claiming the deduction to later years or not taking it at all if planning to sell the property soon (to avoid paying taxable “recapture” depreciation). We advise consulting with your tax advisor to determine the best strategy for your situation.
The Bottom Line
Whether or not you use bonus depreciation, IRS-approved cost segregation studies can help improve your cash flow and return on investment by reallocating building assets to shorter depreciation schedules. Time is ticking to benefit from the full 100% bonus, so it’s advantageous to consider making major or real property purchases eligible for bonus depreciation and putting them into service before year end to maximize your tax savings options.
Cost Recovery Solutions LLC works with commercial property owners and their tax professionals to deliver value-added acquisition services that boost their return on investment. Services include cost segregation studies, energy tax services and tangible asset appraisals/reviews. Learn more by contacting us at 732.548.3855.
Robert Rahner, CFA, ASA, CCSP, is the managing director of Cost Recovery Solutions LLC.