Depreciation is a great incentive to real estate investors to write off a percentage of their taxable income. When it comes to residential real estate, property is depreciated over a set period of 27.5 years. Everything about a property except for the land is depreciable. Let’s say you purchase a rental property for $1MM, and a tax expert determines the land is $200K of that investment. This means $800K will be depreciated over 27.5 years, or a loss of roughly $29K/year.
However, there is a way to realize the depreciation in a much shorter timeframe than 27.5 years. Performing a cost segregation allows an investor to allocate the depreciable assets of the property into buckets of 5, 7 & 15 year depreciation timeframes. A cost segregation expert will literally go fixture by fixture, improvement by improvement to classify which assets falls into what category. This allows you to take much larger losses in nearly half the time.
Taking this a step further leads us to bonus depreciation. Due to the passing of the Tax Cuts and Jobs Act of 2017 investors can take 100% of the depreciable amount in year 1 of the investment. For example, MarketSpace Capital performed a cost segregation on our Main+West Acquisition in 2020 which resulted in 64% depreciation. This means if you invested $1MM in Main&West, you received a K-1 for -$640K for the 2020 tax year.
While bonus deprecation is a great incentive to investors, it will be getting phased out out in increments of 20% over the next 5 years starting in 2023 until we’re at 0% bonus depreciation. To put it into context using the Main&West investment, in 2023 an investor would only receive 80% of the $640K year 1 loss, or $512K. Come 2027 investors will be fully back to receiving their depreciation over the course of 15 years following a cost segregation.
While this is a very high-level overview of a complex topic, we encourage investors to check out this LINK to a webinar with one of our founders, Dr. Masaki Oishi, and cost segregation expert Yonah Weiss. This webinar takes a deeper dive into cost segregations and the benefits of depreciation.
