076: Saying Goodbye to 100% Bonus Depreciation
Have you ever won something after being certain that you lost? Maybe you scored for the other team but still ended up in the championship. Or you totally guessed at trivia night and ended up with the big cash prize anyways? 🤔🤔
That’s how we felt when we first heard about 100% Bonus Depreciation. We were mesmerized by the thought “even if we don’t make passive income from an investment– we’re already winning!”
Because instead of giving our hard-earned money to Uncle Sam, we’re investing those same 💵 dollars and growing it!
It was truly an eye-opening experience for us and we didn’t hesitate to dive deeper into apartment investing and felt secure knowing that 100% Bonus Depreciation had our backs. We got to make more, keep more, and grow more with it! Talk about a win-win-win! What were some of those key lessons for you, Palm?
For me, it was knowing that we could get Uncle Sam in our corner and substantially lower our overall tax bill, thus directly contributing to our family’s bottom line. It was so eye-opening and made me feel confident we could always come out on top no matter the investment.
Apartment investing, in particular, has offered passive investors tremendous tax advantages over the last few years. However, some of those critical tax benefits are phasing out in the coming years, which is exactly what we’ll talk about in today’s episode.
We want you to be aware of the tax advantages as they currently stand, as well as how they’re about to change in the coming years so that you can make the best investment decisions for you and your family. 😊😊
We’ll start by discussing the high-level tax benefits of investing in apartment syndications and then dive into how the Tax Cuts and Jobs Act (TCJA) passed in 2017 has improved tax benefits even further for passive investors in recent years.
Then we’ll break some bad news on how the TCJA will be phasing out in the coming years, so you can wrap your mind around what this will mean for your investments.
Our goal is to bring you to full awareness of what to expect as this information comes in. Your assets are not a place where you want to be blindsided. Now, a disclaimer before we dive into today’s episode. As with anything related to taxes, we always advise that you consult your own CPA.
We are not tax professionals, we’re just two apartment syndicators and passive investors who are sharing our experiences with the best intentions for you to grow your wealth and save on taxes in the process. Now, let’s get into it! 😉😉
Tax Benefits 101
Let’s start with an overview of the tax advantages of investing passively into 🏢 an apartment syndication, as they currently stand. If you’re already a seasoned passive investor and could recite all the advantages by heart with us, feel free to skip ahead.
The first thing you should know is that, as a passive investor, even though you’re not doing the work of fixing toilets, finding tenants, or dealing with trash, you still get the same tax benefits, which flow through the syndication entity (usually an LLC), straight to you as the investor. ✨✨
When you invest as a limited partner, also known as an LP, or passive investor in an apartment syndication, you get a share of the returns based on how much you invest. Similarly, you get a share of the tax benefits as well, as documented by the Schedule K-1 you receive each year.
The K-1 shows your income and losses for that particular asset. In many cases, particularly in the first year of the investment. And usually, the K-1 is some pretty daunting big, negative number.
The magic of the K-1 is that it includes accelerated and Bonus Depreciation. In other words, even while you’re receiving cash flow distributions on an ongoing basis, the K-1 can show a substantial paper loss, which in most cases means you can defer or reduce taxes owed the cash flow you received and proceed from sales. 😘😘
We remember the first time as apartment syndicators we were shocked by the amount of our K-1 paper loss. Like. Physically ill.
We invested $100K on that deal, and the K-1 paper loss we got back was $83K, meaning, the government was investing right alongside us, and we are actually investing in the deal for $17K, and the government contributed the $83K, yet we’re benefiting as if we invested all $100K to begin with.
Tax Cuts and Job Act 2017
Speaking of bonus depreciation and paper losses, did you know that we’ve been living in the heyday of bonus depreciation?
It’s true these are the good ol’ days we’ll look back on fondly. When the Tax Cuts and Job Act (TCJA) went into effect at the beginning of 2018, it ushered in the golden age of bonus depreciation, which we’ve been in since then. 🤩🤩
Prior to the TCJA, the bonus depreciation amount you could take for qualified properties acquired during a particular tax year was much lower (it was 50% immediately before the TCJA was passed, but prior to that it was 30% or lower).
After the TCJA passed, it allowed investors to take 100% Bonus Depreciation on certain types of fixed assets, including the commercial real estate assets we invest in. The exact dates to take advantage of the 100% Bonus Depreciation are for properties acquired and placed into service starting from September 27, 2017, and before January 1, 2023. 😌😌
In other words, there’s a ticking 🕰 clock on this 100% Bonus Depreciation benefit. It is and has always been a temporary thing.
Commercial Break: 50% vs. 100% Bonus Depreciation
Alright alright, we’re talking a lot about BDE– Bonus Depreciation energy– but it’s easier to explain through an example. So let’s walk through a quick scenario so you can better understand the full impact of increased Bonus Depreciation.
Let’s say we buy a commercial multifamily property before the end of 2022, for $33,000,000.
I like it– let’s manifest that! If we take the straight-line approach to depreciation, that means we can depreciate the cost of the building in equal portions, like a straight line, over 27.5 years, which is the depreciation schedule for commercial properties.
However, through the power of cost segregation, we can show that certain elements within the property such as the flooring, light fixtures, etc., can be depreciated over a shorter lifespan. Let’s say those additional elements qualify for accelerated depreciation come out to 25% of the cost of the asset, or $17,750,000.
This is where 100% Bonus Depreciation comes in. This means that 100% of the full $17,750,000 amount in this example can be deducted in that same tax year when the property is acquired and placed in service. The remaining $53.25 million would then be deducted in smaller increments over the life of the asset.
Now, all our cost segregation has been conducted by the 3rd party engineer firm, and for this particular example, the estimated bonus depreciation came back at 80%, meaning, that if you were to invest $100,000 into this apartment syndication, then you would receive a K-1 showing a paper loss of roughly $80,000, given the current allowance of 100% bonus depreciation.
👉 Okay so let’s compare this same example at 50% Bonus Depreciation. Your investment is still $100,000. If that bonus depreciation were to drop to 50%, then the paper loss you’d see would only be around $50,000.
This is particularly relevant if you have significant passive active income (from real estate investments, businesses, or otherwise), and/or you qualify for REPS (real estate professional status), in which case your passive losses could apply to other types of income as well.
Again, everyone’s tax situation is different as well as their assets. So check with your CPA to see if this could work for you too! 😇😇
But regardless of the exact implications for your tax bracket or tax situation, the point stands that greater depreciation now or in the near term is generally better and more desirable.
Why? Because of the time advantage and opportunity cost. If you can pay less in taxes now– even if that depreciation is recaptured later, upon the sale of the asset– that gives you additional time to invest and grow the money you would have otherwise paid toward your tax bill.
Are you getting this whole hype around bonus depreciation? This is why it’s imperative that you take advantage of the 100% bonus depreciation while it’s still available. This brings us to our next topic – the phasing out of TCJA in the coming years and what that means for you.
The Phasing Out of 100% Bonus Depreciation
Much like the Chaco Taco, as we know all good things must come to an end. So it must be true with Bonus Depreciation.
Sigh. I am not looking forward to this so we’ll give it to you straight. As of the time this recording is being written, we are in the last calendar year, 2022, in which you will be able to take advantage of the 100% Bonus Depreciation benefit as laid out by the Tax Cuts and Jobs Act.
Here’s a breakdown of the schedule ⏬
- 2018 to 2022 – 100% bonus depreciation
- 2023 – 80% bonus depreciation
- 2024 – 60% bonus depreciation
- 2025 – 40% bonus depreciation
- 2026 – 20% bonus depreciation
In other words, for apartment syndication investments you make by December 31, 2022, those investments are still eligible for that 100% bonus depreciation.
Keep in mind though, that if you make an investment on December 31, 2022, but the deal doesn’t actually close until January 2023, then that investment would fall under the 80% bonus depreciation guidelines for 2023.
Thus, it’s risky to continue to wait for investment opportunities that may or may not come later this year, particularly if they don’t close by the end of this calendar year.
What this gradual phasing out means for you as an investor is that with each passing year, as the bonus depreciation continues to decline, your tax bill may climb with it which means you need to take advantage of this time sooner than later.
On top of that, President Biden’s proposed Tax Act, had it passed, could eliminate some benefits of the depreciation altogether, and potentially much sooner than 2026. All the more reason to invest now.
Let’s play this out further and see what the implications would be in each subsequent year, assuming we’re talking about the same asset with the same cost segregation slash depreciation potential.
- 2022 – 100% bonus depreciation = $80,000 paper loss (in this example)
- 2023 – 80% bonus depreciation = $64,000 paper loss
- 2024 – 60% bonus depreciation = $48,000 paper loss
- 2025 – 40% bonus depreciation = $32,000 paper loss
- 2026 – 20% bonus depreciation = $16,000 paper loss
A huuuge jump from the original 100% you had a mere 4 years ago. 😱😱
So, where does this leave you, passive investor? It means you need to act now. This is a matter of urgency because we can hear the time clock behind us and it’s catching up fast. If you act now you can benefit from the 100% depreciation as it still stands when you close this year versus waiting another 2-3 years.
If your tax situation is structured in a way that you could apply those passive losses to other streams of passive (or even active) income, that decline in bonus depreciation would mean a substantial shift to your overall tax picture.
And even if you are only able to apply those passive losses to your passive income in that asset directly, that lower bonus depreciation means you’ll have less depreciation to carry forward into subsequent years, meaning your overall tax liability could be higher.
Okay, What’s Next?
We get it, we’re not exactly delivering too much good news today, and if your head feels like it’s swimming in information as you try to strategize what’s next for you and your investments– we were there not too long ago ourselves. It’s totally normal.
The intricacies of tax law and depreciation are not always easy to wrap your mind around– we get this was a lot of beefy content– so the mere fact that you’ve made it this far is an accomplishment already. Go you!
You know our Cashflow Multiplier you are the best so you’ll chew all the beefy content to get to the good stuff and build wealth by saving in taxes!
They are and that’s why we love them. 💜💜 If you take away nothing else from this episode, here’s the one thing you should be aware of. The tax landscape is shifting, and if you continue to do the same thing you’ve done over the last few years, you can expect the same results.
You know what the definition of insanity is, right? Doing the same exact thing over and over and expecting different results each time. It’s just not possible. Especially in this economic season.
Over the last few years, we’ve enjoyed a period of extraordinary tax advantages for real estate investors, where we were able to take advantage of 100% bonus depreciation.
That has translated into significant tax benefits for many real estate investors, but those advantages are phasing out in the coming years. Again, all good things must come to an end buuut the end isn’t here just yet. So if you’re thinking about investing passively in apartment syndication– the time is now.
Seek out investment opportunities that close before the end of 2022 so you can still take advantage of the 100% Bonus Depreciation. If you wait until the end of the year, you could risk putting your money into a deal that doesn’t close until 2023, which would significantly eat into your potential tax savings. 🙏
Particularly when factoring everything else going on right now – including inflation, rising interest rates, and an impending recession, if we aren’t already there yet – it’s important to take action now, so you can make sure the financial foundation for you and your family is on a firm footing.
Alright, so where do you go to find these deals and how do you know the team you’re investing with is the best one out there? Some of you already know where we’re going with this but we have the resource for you! The Kitti Freedom Club. The Kitti Freedom Club is designed for everyday people just like you who are leveling up their high-level investments.
At the Kitti Sisters, we have a variety of options to help you learn about how to invest in real estate so you can take advantage of the tax benefits available to you. We’ll link them in the show notes and in the show description. Join The Kitti Freedom Club today and enjoy all the benefits of 100% Bonus Depreciation before it’s too late! 👋👋
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