Whether right or wrong, there are major loopholes that real estate investors can utilize to minimize their income tax obligations. I don’t write the rules, but I utilize them because ultimately the government incentivizes ownership of land and buildings to promote strong infrastructure. Through recognizing bonus depreciation and carryforward losses, real estate investors can pay next to nothing in income tax when they are actively buying properties.
Let’s say you buy a self-storage facility for $1 million, excluding the value of the land. Commercial buildings depreciate over a schedule of 39 years, meaning each year you can deduct about 2.5% of the property value from your income. Even if you only put $300 thousand down and the rest was financed from a bank, you can still deduct $25 thousand from your income every year as depreciation, and that’s before recognizing bonus depreciation.
Not every component of a building has a 39-year lifespan; roads, sidewalks, landscaping, windows, roofs, etc. all have different definitions of useful life. A cost segregation specialist can break down each component of your building and determine the appropriate cost and timeline for each piece of your property, and anything with a useful life under 15 years can be fully depreciated in year one. Last year we purchased 32 self-storage facilities, $50 million in total value, and recognized over $15 million of bonus depreciation in the first year, a 30% tax loss.
Not all income is treated the same way, and it’s typically categorized as active or passive income. If you are a real estate professional, you can offset your active income with passive losses. For example, if I made $1.5 million in a year but recognize $2 million in bonus depreciation, that means I can wipe away my tax burden for the year. On top of that, through carryforward losses, I could apply the remaining $500 thousand to offset next year’s income.
I highly recommend you take advantage of bonus depreciation and cost segregate every piece of real estate you buy, I recently did it for a $300 thousand property I plan to rent out through Airbnb and was able to pass through almost $40 thousand through year one depreciation; I saved more money in taxes than I spent on the report. There’s a lot of nuance to this, and depreciation ultimately lowers your cost basis which means you’ll pay higher income tax down the road, but a dollar saved now from taxes is more valuable than a dollar saved later. Work with a CPA to get your best understanding of how to take advantage of tax incentives.
Three Key Takeaways
- There are significant tax loopholes that real estate investors can and should take advantage of to save money
- Bonus depreciation and carryforward losses may be able to offset your active income, significantly reducing your tax burden
- Investing in cost segregation can help you minimize your tax obligation and should be down for every property you buy
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