UNDERSTANDING BONUS DEPRECIATION
Bonus depreciation is the same general concept as Qualified Improvement Property and Section 179 expenses covered in our other writings as they all allow for accelerated depreciation.
The following rules apply for Bonus Depreciation:
In order to qualify for bonus depreciation, an improvement must have a useful life of 20 years or less, and must be purchased from an individual or entity that a taxpayer is not related to. So what is being said here is that you can not use bonus depreciation on the cost of the building as the building is depreciated normally 27.5 years or 30 years so the building itself can not be bonus depreciation, but mostly anything else can.
However for real estate owners who have owned their properties a long time, we do not recommend that you just suddenly state there are assets that are less than 27.5 years and suddenly go and take bonus depreciation on it without doing a cost segregation. The reason is that most of those items have already been depreciated on the existing tax returns (like lets say a kitchen sink is already depreciated the normal way and there is not much if any of that left to just go ahead with that. We recommend that if you really want to do Bonus depreciation that you do a cost segregation, by a certified person / company who does this work where they state that this amount of the property can be depreciated in 1 or 2 or 5 years and this other part in 10 years and so forth…. And you have to attach this cost segregation study to your tax return being filed.
Note that bonus depreciation is not a tax savings in the long run as any depreciation taken this year through bonus will reduce the ability for you to take a depreciation at a later time (reduces the basis of property).
Also, bonus depreciation is currently at 100% in 2022 but will decline as follows. What this means is that if the cost segregation study was done in 2022 and they come up with lets say $1,000,000 of assets eligible to be below 27.5 years, then you can take the $1,000,000 deduction all in 2022. If you wait till 2023, you can take $800,000 as the phase out is reducing the amount allowed in the first year.
Again note that in the long run it doesn’t make a difference in the total expenses you are deducting and actually, it might be less beneficial to take everything in the first year as you might be happy to get a big refund in the first year, but your taxes will go up for lack of depreciable basis in the next years and actually, most probably you would be paying more in taxes in the long run. For example, let’s say if a person who makes $1,000,000 take a bonus depreciation of $1,000,000, the high tax bracket suddenly drops at the $418,850 income level to 32% from 37% (which means this person will save 5% less in taxes at these levels, and the tax bracket then drops steeply to 24% below income levels of $329,850 (a reduction of 13% in savings over the 37% rate) and then to 12% or zero percent below that. And these are only Federal rates. So what is being said here is that the tax savings at 12% or 24% or 32% are all less than the tax savings that this person would have steadily received over time if deduction is made at the 37% level using normal depreciation. Of Course there is time value of money that needs to be accounted for here.
The above is only a general summary of the existing law as of the date of this writing and individual circumstances will make a difference. Please contact us if you need us to evaluate things further specifically for you. Representation Note: If you have not signed an engagement agreement with our firm, then we do not represent you, and this notice does not contain any tax advice for you. This posting is for existing clients with signed agreements.
