Bonus Depreciation vs. 1031 Exchanges

[Julio Gonzalez]

Bonus depreciation and 1031 exchanges are two ways investors can lower their tax burdens. But knowing when to use each tool can make a huge difference to your bottom line.

Here’s how they can work for you.

Bonus Depreciation

Bonus depreciation is, essentially, an accelerated way to write off the cost of big purchases. With traditional depreciation, the cost of an asset is spread out over several years. With bonus depreciation, a large chunk of the cost is deducted the year you purchase it.

Generally, anything with a lifespan of 20 years or less can be included, such as:

• Computers and software
• Manufacturing equipment
• Some building improvements (think roofs, HVAC and security systems)
• Office furniture

Bonus depreciation gives you immediate tax savings by lowering your taxable income, freeing up cash flow.

Currently, the bonus depreciation deduction percentage is slated to phase out as follows:

• 2024: 60%
• 2025: 40%
• 2026: 20%

Remember – tax laws are complex, and proposed bills may not pass in their current form. For this reason, it is crucial to consult with a tax professional to make an informed decision.

Bonus depreciation may be a fitting choice if:

• You’re making major equipment purchases
• You have large capital gains from non-real-estate investments (bonus depreciation can help maximize your deductions)
• You anticipate higher taxable income in the current year

1031 Exchanges

The sale of an investment property can lead to hefty capital gains taxes. But a 1031 exchange allows you to delay those taxes by reinvesting proceeds from the sale into another “like-kind” property.

Here’s what you need to know:

• The deferment isn’t permanent
• You have 45 days after the sale to formally identify potential replacement properties
• You must close on the new property within 180 days of the initial sale
• The relinquished property and the replacement property must be held for investment or use in your business
• The replacement property must be of equal or greater value than the one sold

A 1031 exchange may be the right choice if:

• You plan to upgrade to multiple or large properties (instead of losing a chunk of your profit to taxes, you reinvest the full amount from the sale to boost buying power.)
• You want to diversify assets (1031 rules give flexibility within real estate – e.g. exchange an apartment building for a commercial space, raw land for a development site, etc.)

Having a better understanding of bonus depreciation and 1031 exchanges can help you make a more informed decision when it comes to your investments.

What are your experiences with these two tools?