Cost Segregation And Bonus Depreciation
Why is Bonus Depreciation paired with Cost Segregation so powerful?
An example. If Bob owns a property where the building or house is worth $390,000.00. His annual depreciation is $10,000.00 a year for 39 years.
Now, lets say Bob gets a cost segregation study. This reclassifies 30% of his property to be eligible for bonus depreciation. So now Bob’s first year depreciation is $117,000.00.
So with cost segregation and bonus depreciation we are able to increase our first years depreciation a whopping $107,000.00.
This can be expanded further into estimated tax savings by looking at our tax rate. Let us assume that Bob is in the 37% tax bracket. This would put Bob at a federal tax savings of approximately $43,290.00.
With this example applying cost segregation and bonus depcreciation you can see why this strategy is so powerful. The bonus depreciation lets you accelerate your depreciation.
But that’s not all. With this cost segregation bonus depreciation strategy you also still get to take annual depreication for the next 38 years. In this example Bob would still get to depreciate about $7,000.00 a year on his building.
100% Bonus
w/ a Cost Seg first year depreciation- Assuming $390,000.00 building value
- Assuming a cost segregation study was performed
- Assuming 20% of the property got reclassified to 5 YR property
- Assuming 10% of the the property got recliassified to 15 YR property
No Bonus
no Cost Seg first year depreciation- Assuming $390,000.00 buiding value
- Assuming no cost segregation study was performed
- Assuming a standard 39 YR depreication was performed
What is the background on Bonus Depreciation?
Bonus depreciation has a dynamic history, marked by legislative measures aimed at stimulating economic growth and encouraging business investment. Its origins date back to 2002 with the Job Creation and Worker Assistance Act, signed into law by President George W. Bush. This legislation was a response to the economic downturn following the 2001 recession and the September 11 attacks. Initially, it allowed businesses to immediately deduct 30% of the cost of qualified property, offering a significant incentive to spur capital investments through immediate tax relief.
In 2003, the Jobs and Growth Tax Relief Reconciliation Act further enhanced this provision by increasing the immediate deduction rate to 50%. This expansion was part of a broader economic strategy to accelerate recovery by making capital investments more attractive, thereby stimulating production, job creation, and overall economic activity.
The financial crisis of 2008 led to additional enhancements. The American Recovery and Reinvestment Act of 2009, part of President Barack Obama’s stimulus package, extended the 50% bonus depreciation provision through 2010. This extension was crucial in supporting businesses during a period of severe economic uncertainty, helping them maintain cash flow and invest in critical capital improvements.
A significant overhaul came with the Tax Cuts and Jobs Act (TCJA) of 2017, signed by President Donald Trump. The TCJA dramatically increased the bonus depreciation rate to 100%, allowing businesses to fully deduct the cost of eligible property in the year it was placed into service. Additionally, for the first time, the TCJA made used property eligible for bonus depreciation, provided it met specific acquisition criteria. This broadening of scope made the provision more accessible to a wider range of businesses, further encouraging capital investment.
Is Bonus Depreciation Going Away?
The 100% bonus depreciation provision, established under the Tax Cuts and Jobs Act (TCJA) of 2017, is scheduled to phase out gradually beginning in 2023. This provision has provided a substantial tax advantage for real estate investors by allowing them to immediately deduct the full cost of qualifying property in the year it is placed into service. However, unless new legislation is introduced to extend or amend this provision, the phasedown will follow this trajectory:
- 2023: 80% deduction
- 2024: 60% deduction
- 2025: 40% deduction
- 2026: 20% deduction
- 2027: 0% deduction
This gradual reduction means that real estate investors will progressively lose the ability to fully expense qualifying property in the first year and will need to revert to traditional depreciation methods, which spread the deduction over several years. This change will impact the timing of tax benefits and could influence investment decisions and cash flow management.
For real estate investors, the phase-out of 100% bonus depreciation necessitates strategic planning. Investors should consider timing their capital expenditures to maximize the current benefits of accelerated depreciation. For instance, placing qualifying property into service before the end of 2022 will allow investors to take full advantage of the 100% deduction. As the deduction rate decreases annually, the available tax savings will diminish, requiring careful financial planning to optimize investment returns.
Although the phase-down schedule is set, there remains a possibility of legislative adjustments. Historically, bonus depreciation has been adjusted in response to economic conditions. For example, during the 2008 financial crisis, the provision was extended to support economic recovery. Given its effectiveness in driving investment, particularly in real estate, there could be future modifications or extensions if economic conditions warrant additional support.
Real estate investors should remain vigilant and stay informed about potential legislative changes. Adjusting investment strategies—such as accelerating capital expenditures or exploring alternative tax strategies—will be essential as bonus depreciation phases out. Consulting with tax advisors and financial planners can provide valuable insights and help investors navigate these changes effectively.
So why does Bonus Depreciation pair so well with cost segregation?
Cost segregation allows us to activate bonus depreciation through changing the class lives of the property.
Instead of looking at the building as one 39-Year piece of property. Cost segregation segregates the building into different parts that then get sorted into different buckets that have shorter class lives.
You see, you can only use Bonus Depreciation on property that has less than a 20 year class life. So by chopping up the building and sorting it from everything being in a 39 year bucket to being a mixture of 5 year and 15 year buckets.
We can now apply bonus depreciation to our property.
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