Bonus Depreciation: How to Super-Charge Depreciation and Pay No Tax

There is a story in the Old Testament where the Hebrews were wandering around the dessert, and they were concerned about what they were going to eat. In response, God sent manna from heaven every morning to feed them. When the Hebrews saw what laid across the ground with the morning dew, they asked the question, “man hu?” What is it? From then on, they called God’s daily provision manna (man hu). What is it?

Bonus Depreciation: What is it?

I was on a call yesterday with my CPA, and we were talking about bonus depreciation. He calls is manna from heaven. Bonus depreciation is a way to legally accelerate the depreciation you would normally take on a property over a number of years. To understand how bonus depreciation works, you must have a working knowledge of depreciation in general as well as what a cost segregation study is. I’ve written posts on both of these topics which might be helpful to you:

Depreciation: Commercial Real Estate’s Gorgeous Tax Shelter

Cost Segregation: How to Maximize the Tax Benefits of Investing in CRE

The tax law of 2017 gave us this gift of bonus depreciation. It allows you to take all depreciation that is on a personal property depreciation schedule at one time. Here is how it works:

  1. Purchase a piece of property (not your personal residence)
  2. Complete a cost segregation study that separates the components of the building to real property (27.5 and 39 years) and personal property depreciation schedules (5, 7, and 15 year)
  3. Take 100% of the values on the personal property schedules this year

Pretty simple, right?

Let’s put this in context of a deal story. A friend of mine recently developed an apartment complex. Just like if he would have bought the complex instead of building it, he is able to depreciate his development over 27.5 years (27.5 because it is a residential property). Smartly, he performed a cost segregation study, and a big amount of the value was placed on personal property schedules of 5, 7, and 15 years.

I don’t know what the actual numbers were, but let’s suppose he developed the property for $10,000,000. Let’s also supposed that after the cost segregation study, $1,000,000 of value was placed on a 5-year schedule, $1,000,000 on a 7-year schedule, and another $1,000,000 on a 15-year schedule. If he stopped there, he could depreciate $200,000 every year for the first five years from the 5-year schedule ($1,000,000 divided by 5), $142,857,14 every year for the first 7 years from the 7-year schedule ($1,000,000 divided by 7), and another $66,666.67 a year for the first 15 years from the 15-year schedule ($1,000,000 divided by 15). The rest of the $7,000,000 (minus the value of the land which cannot be depreciated) would be depreciated over 27.5 years.

Manna from Heaven

But now add in the impact of bonus depreciation, and you can see why my CPA calls it manna from heaven. Instead of depreciating the $1,000,000 from the 5, 7, and 15 year schedules, bonus depreciation allows my friend to take all $3,000,000 of depreciation…this year, plus the normal depreciation of the remaining $7,000,000 that remains on the 27.5 year schedule! That means that my buddy can make more than $3,000,000 this year and have taxable income of zero. He would pay no income tax.

Some Caveats

First – Depreciation, bonus or otherwise, only offsets passive income. Passive income includes rent from investment real estate, profits from an ownership in a business that you don’t actively participate in, etc. It does not offset ordinary income like your W-2 income. Real estate professionals are the exception. All income for a real estate professional can be wiped out by depreciation.

Second – Depreciation can be carried forward. If my buddy didn’t make $3,000,000 or more this year in passive income (and I’m guessing he didn’t), he can offset passive income from future years. In his case, since he is a real estate professional, all of his income is eligible to be offset by depreciation. This may not be the case for you.

Third – If you didn’t do a cost segregation study when you bought your property, you can still do one now to access the benefits of bonus depreciation.

Fourth – Bonus depreciation is sunsetting. You can bonus depreciate 100% of the 5, 7, and 15 year schedules in 2022. In 2023, it goes to 80%. In 2024 – 60%. In 2025 – 40% – and so on until it is gone. Time is ticking!

If you are wondering whether you should look at cost segregation and bonus depreciation for a property you own, or you are interested in investing in commercial real estate so can receive some of this manna from heaven, we’d love to talk to you. Simply click the button below to schedule a call.