2022 Is The Last Year For 100% Bonus Depreciation – Here’s Why It Matters And What You Need To Know

I remember the first time I realized the direct impact that Uncle Sam had on my day-to-day life. My first job out of college was as a 4th grade teacher with Teach For America, working to close the opportunity gap.

The Friday of the second week of school, I was not only excited for the weekend ahead, but I was also excited to get my first paycheck. At the time, the salary for a first-year teacher in the state I was teaching was $44,000, which came out to about $1,700 every 2 weeks.

It wasn’t much, but I was looking forward to that paycheck. So imagine the look on my face when I opened up that paycheck and saw not $1,700, not $1,500, but $1,045. 

That’s right, nearly a third of my salary had been eaten up by taxes and other fees. 

That moment was an eye-opening experience for me. A moment in which I realized in plain black and white the chilling realities of the long hours I was putting in, versus the return I was getting on that time.

Over the years, as I’ve delved further into real estate investing, I’ve realized what an incredible opportunity real estate is for helping everyone – teachers, nurses, engineers, bus drivers, parents, retirees, etc. – to not only MAKE more, but KEEP more of what they make.

And I’ve learned that, when you learn how to get Uncle Sam in your corner, you can substantially lower your overall tax bill and thus directly contribute to your family’s bottom line.

Commerical real estate syndication (group investments), in particular, have offered investors tremendous tax advantages over the last few years especially. However, some of those critical tax benefits are phasing out in the coming years, which is exactly what we’ll talk about in this article.

We want you to be aware of the tax advantages as they currently stand, as well as how they’re changing 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 real estate syndications, 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, and how the TCJA will be phasing out in the coming years, so you can wrap your mind around the potential impact for your investments.

Before We Get Started…

First, a disclaimer. As with anything related to taxes, we always advise that you consult your own CPA. 

We are not tax professionals, so please take anything we say here with a grain of salt. 

We are sharing what we know to the best of our knowledge and with the best of intentions, but please confirm everything regarding your own unique tax situation with your own CPA.

Okay, with that out of the way, let’s get the show on the road!

Passive Real Estate Investing Tax Benefits 101

Let’s start with an overview of the tax advantages of investing passively into a real estate syndication, as they currently stand. If you’re already a seasoned passive investor, 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 or finding tenants, you still get the same tax benifits, which flow through the syndication entity (usually an LLC), straight up to you as the investor.

When you invest as a limited partner (LP) passive investor into a real estate 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 would 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, that K-1 can show a whopping negative number.

Wait a second, a negative number?? Why would you invest in real estate if it’s losing you money, you ask? Excellent question, grasshopper.

The magic of the K-1 is that it includes accelarated and bonus depreciaton.. In other words, even while you’re receiving cash flow distributions on an ongoing basis, the K-1 can show a paper loss, which in most cases means you can defer or reduce taxes owed on the cash flow you’ve received. 

Reminder: Double check everything with your CPA!

Did You Know? 

The tax benefits for a real estate syndication are completely different from those for a REIT (real estate investment trust).

A Brief History Of Bonus Depreciation

Speaking of bonus depreciation and paper losses, did you know that we’ve been living in the heyday of bonus depreciation? 

It’s true – when the Tax Cuts and Job Act (TCJA) went into effect at the beginning in 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 that 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 had been at 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.

In other words, there’s a ticking clock on this 100% bonus depreciation benefit. It is and has always been a temporary thing.

A Quick Example Of 50% Versus 100% Bonus Depreciation

Let’s walk through a quick example so you can better understand the full impact of this increased bonus depreciation. Let’s say that we buy a commercial multifamily property before the end of 2022, for $60,000,000.

If we take the straight-line approach to depreciation, that means we can depreciate the cost of the building in equal portions (i.e., in a straight line) over 39 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 (let’s say, the flooring, light fixtures, etc.) can be depreciated over a shorter lifespan. Let’s say those additional elements that qualify for accelerated depreciation come out to 25% of the cost of the asset, or $15,000,000.

With 100% bonus depreciation, that means that 100% of that amount (the full $15 million in this example) can be deducted in that same tax year when the property is acquired and placed in service. The remaining $45 million would then be deducted in smaller increments over the life of the asset.

Now here’s where the magic comes in for you as a passive investor (which, remember – as a passive investor, you get your portion of the pass-through tax benefits, including the bonus depreciation).

Let’s say that the total equity needed for the property is $18,500,000 (this includes the down payment, plus reserves and any additional funds for the intended business plan).

If the cost segregation can show that $15 million of the overall asset qualifies for accelerated depreciation in that first year, that means that the total depreciation amount would be roughly 80%.

If you were to invest $100,000 into that syndication, then you would receive a K-1 showing a paper loss of roughly $80,000, given the current allowance of 100% bonus depreciation.

Your Investment

$100,000

Paper Loss In This Example, At 100% Bonus Depreciation

$80,000

If that bonus depreciation were to drop to, say 50%, then the paper loss you’d see would only be around $40,000. 

Paper Loss In This Example, At 50% Bonus Depreciation

$40,000

This is particularly relevant if you have significant passive activity 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, check with your CPA on the direct implications for you and your tax situation.

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 sale of the asset), that gives you additional time to invest and grow the money you would have otherwise paid toward your tax bill.

This is why it’s imperative that you take advantage of the 100% bonus depreciation while it’s still available. Which brings us to our next topic – the phasing out of TCJA in the coming years and what that means for you.

The Timeline For Phasing Out 100% Bonus Depreciation

All good things must come to an end, and so it must be with 100% bonus depreciation as well. Sigh.

Currently, as of this writing, we are in the last calendar year in which you will be able to take advantage of the 100% bonus depreciation benefit as laid out by the TCJA.

The 100% bonus depreciation is set to phase out on the following 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 commercial real estate 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 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, which means it’s to your advantage to invest now rather than years from now.

On top of that, President Biden’s proposed Tax Act, if passed, could eliminate the bonus depreciation altogether, and potentially much sooner than 2026. All the more reason to invest sooner rather than later.

Bonus Depreciation Example Scenarios

Let’s say you were to invest $100,000 in a deal that closes by the end of 2022, and that in 2023, you receive a K-1 that shows a paper loss of $80,000 (which in this case represents 100% bonus depreciation).

If you were to invest in that same asset in 2023, the K-1 you would receive in 2024 would only show 80% of that $80,000. In other words, you would have a paper loss of $64,000 rather than $80,000.

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 / 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

That means that, for the same investment amount in the same asset, your paper loss for your 2026 taxes would be a mere fraction of the depreciation for that same asset, as applied to your 2022 taxes. In this example, the depreciation would be $64,000 lower in 2026 than in 2022.

If your tax situation is such 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 for subsequent years, meaning your overall tax liability could be higher.

Again, please please please double and triple check everything with your own CPA to verify how all of this would apply to your unique tax situation.

What Next – Implications For Your Overall Investment Strategy

Given everything we just walked through, it’s completely normal if your head feels like it’s swimming right now. 

The intricacies of tax law and depreciation are not always easy to wrap your mind around, so just the mere fact that you’ve made it this far is an accomplishment. Go you!

If you take away nothing else from this article, 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’t expect the same results.

Over the last few years, we’ve been enjoying 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.

So, if you are thinking of investing passively in a real estate syndication, the time to do it 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 evertything else going on right now – including inflation, rising interest rates, and a potential recession – it’s important to take action now, so you can make sure the financial foundation for you and your family is on firm footing.

Here at onbrigecapital, we have a variety of options for you to help you learn about and invest in real estate so you can take advantage of the tax benefits available to you. Below are a few resources to get you started.

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