Bonus Depreciation and Recapture

Happy long weekend!


Can’t believe that a quarter of 2021 has passed! Time to review your portfolio and compare to it to your plan. I am quite happy to see the growth of my passive portfolio, which is a nice diversification to my equity portfolio.

Today, we are going to talk about some basic concepts of tax benefits of real estate investments. This is a hot topic under the backdrop of tax hike of Biden administration. Please bear in mind that I am not a CPA or tax advisor, my understanding can be wrong. Please consult your CPA.


Depreciation

Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy, resulting in reduction of taxable income. Please note that the useful lives are different for different asset classes. For instance, useful life is 27.5 years for residential and 39 year for commercial real estate.


Straight-line depreciation, accelerated depreciation and bonus depreciation

Straight-line depreciation means that you get the same tax benefit every year, while accelerated depreciation means you get most of the tax benefit upfront. Of course, you want to get 100% of the tax benefit (paper loss) in year 1, but is it possible?

Well, it depends on two things:

1) The year you invest

Thanks to the Tax Cuts and Jobs Act of 2017 (TCJA), you can write off up to 100% of the cost of eligible property purchased after September 27, 2017 and before January 1, 2023, up from 50% under the prior law. However, that 100% limit will begin to phase down after 2022: 80% for 2023; 60% for 2024; …; and finally, 20% for 2026. So if you want to take advantage of bonus depreciation, do it before it goes away.

2) The asset class you invest in

Not all the asset classes can enjoy 100% bonus depreciation. The current rate for multifamily is about 40-60%, due to the land, permit and other fees, and cash reserve, but investing in an equipment such as an ATM machine gives you100% bonus depreciation.


Bonus depreciation and depreciation recapture

The realized gain from an asset sale (the difference between the sale price and the adjusted cost basis) must be compared with the accumulated depreciation. The smaller of the two figures is considered to be the depreciation recapture.

For example, if a business equipment was purchased for $10,000 and had a depreciation expense of $2,000 per year, its adjusted cost basis after four years would be $10,000 - ($2,000 x 4) = $2,000. If the equipment is sold for $3,000, the business would have a taxable gain of $3,000 - $2,000 (adjusted cost basis) = $1,000, it will be taxed as ordinary income.

A lot of investors ask me “what’s the point of bonus depreciation in year 1, if there is a depreciation recapture in year 5. I still think bonus depreciation is meaningful for two reasons.

  1. What if your tax bracket in year 5 is different from your current tax rate?

  2. Even if everything is equal, it’s still better to defer tax payment, as all the money has time value, remember?

There is no depreciation to recapture if a loss was realized on the sale of a depreciated asset.

For multifamily, most of the time, it’s sold for profit, so there is always a recapture (which is a good problem to worry about). For assets with short useful life, it’s very often to be sold when there is not much value left. For instance, for ATM investment, you can enjoy 100% bonus depreciation in year 1 and no depreciation recapture at the end!

Although we talk about a lot of tax benefits of real estate investments, I would like to point out the favorable tax treatment is just icing on the cake. It shouldn’t be the only reason of your investment. On the other hand, a good investment is still a good investment, even if you don’t get the best tax treatment comparing to other investments.

Lastly, we want to announce our next webinar... On Monday 4/5 8:00 pm ET / 5:00 pm PT, accredited investors are invited to an exciting co-investing opportunity in an investment like no others. Register here as spots are limited.

Depreciation

Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy, resulting in reduction of taxable income. Please note that the useful lives are different for different asset classes. For instance, useful life is 27.5 years for residential and 39 year for commercial real estate.

Straight-line depreciation, accelerated depreciation and bonus depreciation

Straight-line depreciation means that you get the same tax benefit every year, while accelerated depreciation means you get most of the tax benefit upfront. Of course, you want to get 100% of the tax benefit (paper loss) in year 1, but is it possible?

Well, it depends on two things:

1) The year you invest

Thanks to the Tax Cuts and Jobs Act of 2017 (TCJA), you can write off up to 100% of the cost of eligible property purchased after September 27, 2017 and before January 1, 2023, up from 50% under the prior law. However, that 100% limit will begin to phase down after 2022: 80% for 2023; 60% for 2024; …; and finally, 20% for 2026. So if you want to take advantage of bonus depreciation, do it before it goes away.

2) The asset class you invest in

Not all the asset classes can enjoy 100% bonus depreciation. The current rate for multifamily is about 40-60%, due to the land, permit and other fees, and cash reserve, but investing in an equipment such as an ATM machine gives you100% bonus depreciation.

Bonus depreciation and depreciation recapture

The realized gain from an asset sale (the difference between the sale price and the adjusted cost basis) must be compared with the accumulated depreciation. The smaller of the two figures is considered to be the depreciation recapture.

For example, if a business equipment was purchased for $10,000 and had a depreciation expense of $2,000 per year, its adjusted cost basis after four years would be $10,000 - ($2,000 x 4) = $2,000. If the equipment is sold for $3,000, the business would have a taxable gain of $3,000 - $2,000 (adjusted cost basis) = $1,000, it will be taxed as ordinary income.

A lot of investors ask me “what’s the point of bonus depreciation in year 1, if there is a depreciation recapture in year 5. I still think bonus depreciation is meaningful for two reasons.

  1. What if your tax bracket in year 5 is different from your current tax rate?

  2. Even if everything is equal, it’s still better to defer tax payment, as all the money has time value, remember?

There is no depreciation to recapture if a loss was realized on the sale of a depreciated asset.

For multifamily, most of the time, it’s sold for profit, so there is always a recapture (which is a good problem to worry about). For assets with short useful life, it’s very often to be sold when there is not much value left. For instance, for ATM investment, you can enjoy 100% bonus depreciation in year 1 and no depreciation recapture at the end!

Although we talk about a lot of tax benefits of real estate investments, I would like to point out the favorable tax treatment is just icing on the cake. It shouldn’t be the only reason of your investment. On the other hand, a good investment is still a good investment, even if you don’t get the best tax treatment comparing to other investments.

Lastly, we want to announce our next webinar On Monday 4/5 8:00 pm ET / 5:00 pm PT, accredited investors are invited to an exciting co-investing opportunity in an investment like no others. Register here as spots are limited.

For the past 9 years, this strategy has consistently delivered high cash flow on a monthly basis. You can also enjoy tax benefits like a multifamily deal. What's the best part? We can achieve these benefits WITHOUT using any leverage.

If you are looking for

  • more stable and predictable cashflow in an uncertain market, OR

  • offsetting potential tax hike with bonus depreciation, OR

  • a way to improve your risk adjusted return of your portfolio

You may consider adding this opportunity to your portfolio!

Join me on Monday 4/5 at 8:00pm ET/ 5:00pm PT and I'll tell you everything about this deal.

Sign Up Here


Invest with Confidence





Yan Yan

Sharpe Investor Group

www.sharpeinvestorgroup.com

Want to invest for passive income? Click here

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