I want to talk for a minute about bonus depreciation because it presents a huge tax-saving advantage in real estate.
When I purchase a computer mouse for my business, or gas for my business vehicle, I can write that off in my taxes for the year. The useful life for these objects isn’t more than one year. But with property, the IRS assigns a longer useful life–39 years in the case of commercial property–and I then deduct the total property value (excluding land) in even amounts over the course of 39 years.
But the thing is, our tax code doesn’t apply a 39-year lifespan to every component of the property. Things like landscaping, HVAC, flooring, light fixtures, windows, etc. can all be depreciated faster than 39 years. And anything with a useful life under 15 years can be accelerated so be written off in year 1.
To pull back, the first step of this process is a cost segregation study. This is when an outside firm will come to your property and break down the value and lifespan by component. Of your $1M property, the windows may be worth $10K with a useful life of 7 years, the HVAC worth $35K with a useful life of 10 years, and so on. Cost segregation breaks your building down into component pieces, assigns a tax code and lifespan to everything in the building, and then gives you a new depreciation schedule based on these components. The beauty of this is it allows you to frontload your depreciation, and therefore your tax savings.
Bonus depreciation allows you to take all the property components with a useful life of under 15 years and write off their value in year 1. This is the ultimate acceleration of the depreciation curve. And as of 2017, the new tax code ruled that used properties were eligible for bonus depreciation. This opened up bonus depreciation to a ton of more people.
In 2021 I bought $50M of storage, and $12.5M of that (25%) was eligible for bonus depreciation. On top of that, only $20M of the purchase price was in equity. This means we put $20M of cash down on these purchases and got a $12.5M tax deduction in year 1. That tax deduction frees us up to take on more deals, and therefore more tax savings, in the years to come.
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