How does accelerated depreciation work + request for resources

Question

One thing often mentioned on the BP podcasts is benefiting from accelerated depreciation for tax purposes (specifically, I'm talking about taking a 100% depreciation in the year of purchase). I recently reached out to an accountant and they gave me a very different picture than what is often presented by BP (or at least, my understanding of it), so I'm hoping people here can help clarify how exactly this works and share some resources (ideally including links to the specific parts of the tax code that allow for this).

My understanding is that you need to do a segregation study as certain parts of the purchase (such as land and structural elements) cannot be depreciated, but everything else is pretty much fair game. However, that accountant I spoke with said the following:

- The special depreciation only allows the 100% deduction in the year the asset is placed in service (sounds like this disallows repurchasing?)

- The special depreciation generally (only?) applies to property with 20 years or less useful life (how is this determined?) and that it must be placed in service before January 1, 2023 (is this exemption being removed?)

Given the above, it sounds like most buildings are not eligible, however the BP podcast makes it sound like this is the standard approach. Would love some help filling in the blanks of my knowledge/correcting my misunderstandings.

Thanks!

Greg Scott · Answer

You have mixed two terms here, creating confusion. Let me help clarify.

For any piece of real estate with improvements, you are allowed to take straight line depreciation. For residential real estate, you would depreciate the property over 27.5 years. The math is as follows: take the purchase price, subtract the valuation of the land, and divide the remainder by 27.5. You get to deduct that every year.

Cost segregation is the process of taking a piece of real estate and identifying the costs of its individual components. For example, a single-family rental may include a driveway, some brick, plumbing, carpeting blinds, appliances, etc. Rather than depreciate the entire building in one lump some over 27.5 years, the government says some things wear out faster. Your cost seg study and your CPA will know that carpet, for example can be depreciated over 5 years. Other items depreciate over 10 or 15 years, and things like the brick on the building will depreciate over the 27.5 years we originally talked about. If you start depreciating these items at their component rates, you are accelerating the depreciation. The total amount of depreciation over 27.5 years is the same amount but this process lets you take more depreciation up front and less at the end.

The Trump tax changes allowed you to take everything that depreciated at 15 years as less and write it off in the first year of ownership. This is called bonus depreciation. Yes, it must be taken in the first year. Yes, it starts phasing out. So, this wonderful incentive will soon be gone, but accelerated depreciation will remain.

The comment on useful life makes no sense. A properly maintained building can last indefinitely. For depreciation, the government doesn't care the age of the property or its condition. I can buy a 100 year old dilapidated shack and take depreciation on it. I think what your CPA was saying is that if you are already into 7 years of ownership (using 27.5 year straight-line depreciation), trying to implement accelerated depreciation may not make sense. This is typically something started the year of purchase.

Michael Plaks · Answer

@Victor B.

You're asking for references to the tax code. Have you ever tried to read it? Unless you're an accountant or an attorney, forgeddaboutit. Don't believe me? Start here https://www.law.cornell.edu/us... and report how far you got before giving up. :)

You're then asking about resources. But you already used so-called resources in the form of BP podcasts. You want to get yourself confused even further by reading/listening to this highly technical and often misunderstood (including by the podcasters) material?

Get a conference with your CPA and have him/her explain how these complex rules apply to your particular situation, as it's often case by case.

To your specific question - "the first year" (or, more accurately, the year placed in service) applies not to the house in its entirety but to each separate asset. For example, if you buy appliances in 2023, they will have 2023 as their year in service. It does not matter when you bought the house where these appliances are being installed.

Basit Siddiqi · Answer

'year the asset is placed in service' is when you placed the property in service, not necessarily when the property was built.

Victor B. · Answer

@Julio Gonzalez Thanks for the links; they confirmed my current understanding. In your second post, you give the example of a $5M building with the study showing that $1M of that falls under the bonus depreciation category. Do you have an estimate/rule of thumb of the approximate ratio of what does and what does not fall into that bonus category?

In your example, 20% of the purchase price falls into the bonus category. In practice, do you feel that is a representative ratio, or is it closer to say 50%? 80%?

Obviously I understand there are a lot of factors at play here and it would be impossible to give a number for every case, I'm just trying to get an approximate sense (even bucketing is useful, for example, maybe commercial is usually 20%, MFH is 40%, and SFH is 60%, or something).

Thanks!

Julio Gonzalez · Answer

@Victor B. Here are a couple of articles I wrote to breakdown bonus depreciation!

https://www.biggerpockets.com/...

It can be pretty complex and requires specific documentation per the IRS, so I would definitely recommend discussing this with your CPA if it's a tax strategy that you are wanting to implement.

Victor B. · Answer

@Michael Plaks Thanks for the link! You were mostly right; I got to about 30% of the way down the page before skimming the rest (and then read section (i) on the $25k offset for rental real estate activities in its entirety, before realizing that it likely isn't what I was looking for). I did find this IRS page though that had a good summary: https://www.irs.gov/newsroom/n...

I asked for more resources because I think it is important to draw wisdom from multiple sources (or one primary source from the governing entity). Greg helped clarify a lot, and I felt well prepared to take another swing at fully understanding this ruleset. That said, you have another very good point (that I hadn't considered), that any non-primary source has to themselves understand what they're talking about, and before this exercise of reading the Cornell interpretation of the law, I assumed the average person stood a reasonable chance of understanding it, but I don't think that's the case anymore, unfortunately.

Yes, thank you. The information I was missing here (or that didn't click for me) is that the accelerated depreciation is not a real estate specific bonus, though I should've realized that based on the cost segregation study.

Thank you both very much for your time and expertise! :)

How does accelerated depreciation work + request for resources

How does accelerated depreciation work + request for resources

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