The tax benefits of real estate begin with depreciation, which you can build on with bonus depreciation. If I buy a building, the IRS deems that it has a long (39 years for commercial real estate) useful life. That means that over the course of 39 years, I can slowly deduct the loss of 1/39th of the property value per year from my income. The beautiful thing about real estate is that historically the building’s value increases over time as you depreciate it, and you have access to leverage (debt) against the property. There are only so many businesses where you can put 20% down on an investment and realize the full value of its appreciation.
Straight-line depreciation sounds great because you can offset your income and pay less in taxes for decades. But Congress has created bonus depreciation which can supercharge your tax savings even more. Your building that has a 39 year lifespan is really made up of a ton of components that each have their own useful life like windows, doors, roofing, and other features. For components with a lifespan under 15 years, you can deduct their full value in your first year of ownership. This is how real estate investors frontload their tax savings and end up paying minimal income tax on a yearly basis when they’re still buying properties. And there’s no other business that lets you buy long-life, appreciating, cash-producing assets and get a major tax deduction the year that you buy them.
Your tax savings can be seriously supercharged if you qualify as a real estate professional. There are two main types of income: active income (your W-2 job) and passive income (stocks, dividends, and other earnings you’re not actively driving). Bonus depreciation generates a passive loss, meaning it can’t offset your active income. But if real estate is your main gig, your losses in real estate can offset gains from active income. The criteria for a real estate professional is that 750 hours and more than half of your working time is spent in real estate.
Some people are against bonus depreciation because it can come back with a hefty tax bill when you sell. Bonus depreciation lowers your basis as you defer taxes to the future, so when you sell you’ll need to pay recapture on that pull-forward. But that’s not a bad thing, you’re taking out an interest-free loan on taxes from the government. You can utilize and invest that money until you owe it back, and it’s easier to pay back after you just got a huge cash influx from selling.
The last major tax advantage we discussed was the 1031 exchange, which allows you to sell a property but still push its tax bill down the road. If you sell a property but replace it within 180 days you effectively take your basis from the old building and put it in the new one. You can buy a building for $1M, sell it for $5M years later, and still delay your taxes for that income if you identify and buy a similar building within the allowed time window.
There are tons of other tax advantages and loopholes like short-term rentals, utilizing real estate for your business, qualified opportunity zones, and passing property on to your children. The government wants to incentivize folks to buy, build, and invest in real estate, and they reward those who do. And at RECostSeg.com we make the process of getting a cost segregation study down and unlocking your bonus depreciation easy and affordable.
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