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December 18, 2023 | read

How Real Estate Investors Can Boost First Year Depreciation

Brandon Hall

Real estate is one of the best tax shelters out there, but many landlords don’t know how to maximize their write-offs and minimize their taxes.

Real estate investors can shelter income produced by their rental real estate via depreciation deductions. What many investors don’t know is that they can drastically boost their depreciation deduction in the first year that they hold their rental real estate. This can create huge windfalls in terms of tax savings.

In this article, I’m going to give you a couple of tips that you can use to drastically increase your tax savings on your next real estate investment.

Cost Segregation Studies

The first tip is to get a cost segregation study performed whenever you buy a new property. A cost segregation study is the practice of allocating value from the building to the various components that make up the building. Instead of allocating 100% of the value to the building and land, a cost segregation study allows us to reallocate value between personal property, land improvements, the building, and land. That means when you’re done with a cost segregation study, you will have value allocated to 5, 7, 15 and 27.5-year property rather than allocating all value only to 27.5-year property. The results of this allocation mean that we’re going to be able to write off components over a faster time period. Writing things off over five years is going to result in higher depreciation rather than writing that same component off over 27 and a half years. Your fridge is not going to last 27-1/2 years, so a cost segregation study takes some amount of that purchase price and allocates some value to that fridge at a 5-year rate, rather than 27-1/2 years. A cost segregation study helps you write things off faster, so your depreciation deduction will drastically increase over 5 years.

You don’t have to spend thousands and thousands of dollars on a cost segregation study. You can do a mini cost segregation study all by yourself. The results won’t be near as good, but you can find the make and model number of parts and appliances, small things that are moveable from one property to the next. You can check those prices on online registers like eBay.

100% Bonus Depreciation

The second tip, thanks to The Tax Cuts and Jobs Act of 2017, is that we can use 100% bonus depreciation for any component with a useful life of fewer than 20 years.

We just covered that a cost segregation study will allow us to allocate value to components with a useful life of 5, 7, 15 and 27.5 years. The nice thing about bonus depreciation is that 100% of the value that we allocated to the five, seven and 15 year property can be immediately expensed in the first year, assuming that we do the cost segregation study in the first year of ownership.

Utilizing bonus depreciation and a cost segregation study will result in writing off about 20-30% of the purchase price of your real estate in the first year. As you can see, this results in large passive losses that you may be able to claim, saving you lots of money on taxes.

Considering Passive Losses

The amount of passive losses that you can take on your personal tax return depends on your modified adjusted gross income and your status as a real estate professional. If you’re not a real estate professional, you’re limited to taking $25,000 of passive losses if your modified adjusted gross income is below $100,000. If your modified adjusted gross income exceeds $150,000, that $25,000 passive loss allowance is completely phased out. That means that any passive losses that you have will be suspended until they can be used in the future. The exception to this rule is that if you qualify as a real estate professional and you materially participate in your rental real estate activities, you can claim an unlimited amount of passive losses against your other income. In years that you run a cost segregation study and claim 100% bonus depreciation, you’re going to maximize the benefit if you also qualify as a real estate professional.

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