The new tax law allows Bonus Depreciation on used equipment and equipment affiliated with residential rental real estate providing significant tax benefits for investors who purchase or place-in-service buildings and building components after September 27, 2017, according to Tom Wheelwright, CPA (https://wealthability.com/tom/).
Investment real estate has 4 components:
- Land – not depreciable,
- Building – depreciated over 27 1/2 years (if residential) or 31 1/2 years (if commercial),
- Land Improvements, – parking lots, landscaping, etc.; typically depreciated over 15 years.
- Contents – appliances, heaters, water heaters, cabinets, fireplace mantels, doors, locks, carpet, etc. which are typically depreciated over 5, 7, or 10 years.
An engineering study determines the relative value of these 4 components. For small properties, such a study can be completed for about $5,000. Studies for larger properties with more complex component structures would cost significantly more. With a monetary value placed on each component, the purchaser can take a fully write-off of Land Improvements and Contents, in the year of acquisition,
If an investor does not take advantage of Bonus Depreciation, traditionally the investor would allocate 20% towards Land, with the balance depreciated over 27 1/2 years. So, a $500,000 apartment building purchase would allocate $100,000 to land. The $400,000 building value nets the investor an annual tax deduction for depreciation of $14,545.
An investor taking advantage of Bonus Depreciation, in our example of an apartment building purchased for $500,000, typically/averages 30% of the price allocated to Land Improvements and Contents, so the investor gets an immediate tax deduction of $150,000 in the year the property is purchased. Deducting the same $100,000 for land value, leaves $250,000 depreciated over 27 1/2 years, to a tax deduction of $9,090.
An important consideration is whether such a deduction can be used. Losses from real estate offset income and gains only from other rental properties; they cannot be used to reduce W-2 income, business income or income from stocks and bonds unless the taxpayer (or his spouse) is a “real estate professional” as defined in the Internal Revenue Code. A real estate professional is some who spends at least 750 hours per year (about 15 hours per week) actively and materially engaged in some aspect of the real estate business (such as a real estate agent, appraiser, banker/lender, etc).
What would be the impact to you if you could deduct $159,090 from your income this year instead of just $14,545?
Jerry Lotz is a local engineer performing cost segregation studies at a reasonable price. Jerry can be reached at 410-878-2553 or firstname.lastname@example.org
The above information is for illustration and general discussion purposes only. Ben Frederick Realty, Inc., and its staff, are licensed real estate brokers specializing in apartment and investment properties and are neither lawyers nor accountants. Readers are advised to check with their legal and tax advisors to determine the impact on each individual situation.