Ways to earn Bonus depreciation?

Question

I'm looking to invest into real estate, if someone can please help guide me about which type of property would allow me to earn an bonus depreciation?

Jack Martin · Answer

@Candace Price it is important to understand which type of property will garner the highest amount of bonus depreciation.  Bonus depreciation is derived from the portion of the property's value with a 15 year depreciation schedule or less. Therefore the property types that are the most favorable to generate bonus depreciation will be those with a high degree of what the tax code refers to as "land improvements".  Those property types are things like mobile home parks, RV parks, and golf courses where the value of the property is not primarily derived from the building(s) but rather from the improvements to the land.  In a mobile home park or RV park, most of the value is in the underground infrastructure, roads, landscaping, amenities, pools, fencing, pads, utility pedestals, etc, while only a small portion of the value comes from a building. In a similar fashion, if you can imagine how much landscaping is in a golf course as compared to the clubhouse, that will give you an idea why an extremely high percentage is allocated to land improvements.

When a property is purchased, a cost segregation study is performed, wherein the value of the property is segregated into land (which is not depreciated), buildings (which are depreciated on a 39 or 27.5 year schedule), land improvements (15 year schedule), and other smaller items like personal property. At the election of the property owner bonus depreciation can be taken, which means 100% of that portion of the property's value allocated to those 15 year or less items can be taken as a passive loss in the year the property was purchased. Properly executed, an investment in these kinds of property can garner passive losses equal to or greater than the amount of capital invested.

Because of this, we tend to see investors that are seeking passive losses look to our MHP strategy as a solution. This can be particularly valuable if they have experienced gains in the same calendar year, expect to experience gains, or expect to sell an investment property and want an alternative to a 1031 exchange. On that note, if you invest passively in a syndication (direct investment or a fund) alongside other investors, you will still receive your pro rata allocation of bonus depreciation on your K1 along with the other investors.

Keep in mind, each of these types of real estate have different intrinsic performance characteristics, so make sure you understand the property type's risks and potential as an investment on it's own.  Be careful not to invest in a poorly performing property simply for the depreciation. In that same vein, if you are investing passively in a syndication for bonus depreciation benefits make sure you vet the sponsor and understand the investment vehicle before you invest.  Bonus depreciation is great, but when you combine that with great investment properties that produce cash flow and appreciation, you have the best of both worlds.

All the best,

Jack

Brock Mogensen · Answer

Cost segregation study - it will provide you with year 1 bonus depreciation. You can do a cost seg on any size property, but it generally starts to make more sense (when weighing in the fee to perform the study) on larger properties.  I've done cost segs on properties as small as $500K but the benefit is much better on larger properties.

Evan Polaski · Answer

@Candace Price, you have some great answers here that directly answer your question.  The piece that I also remind myself is bonus depreciation is a deferral strategy, and under current tax law is depreciation recapture is often taxed higher than long term gains.  Now the spread in these rates is not huge, but it is technically a higher rate.

Also, depending on where your capital is coming from, you may not be able to utilize any or all of the bonus depreciation anyways.  This is a matter for your CPA, since it contingent on your personal status, but something to consider if there is significant benefits to you, or if you will essentially be carrying over most of your losses anyways.

And the most important piece that I remind myself, and Jack made clear at the end of his post: investing, to me, should be focused on the fundamentals of the investment, with the tax benefits being the icing.  There are several investments I have considered, and some I jumped on, that are structured in a way that I won't receive any bonus depreciation, but I still made them because I believe in the product type and the sponsor.

Ways to earn Bonus depreciation?

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