Understanding When to Use Bonus Depreciation and/or 1031 Exchanges

[Julio Gonzalez]

They always say that there are only two things that are certain in life - death and taxes. However, that doesn’t mean that there aren’t strategic ways to lessen or defer your taxes! As a real estate investor, it’s crucial that you understand when and how to utilize bonus depreciation and 1031 exchanges in order to lessen your tax burden, keeping more money in your pocket. These tools can be used separately or together depending on the situation. Let’s take a deeper dive.

Bonus Depreciation

Depreciation allows you to deduct the cost of an asset over its useful life. However, bonus depreciation allows you to accelerate the deduction, sometimes as much as 100% in the year that you buy it. This generally includes anything with a useful life of 20 years or less such as software and computers, equipment, specific building improvements and office furniture.

When to consider bonus depreciation?

• New large investment in equipment:
• Current-Year deductions are needed
• Investment gains need to be offset

1031 Exchanges

Typically when you sell a property, it will be a value higher than what you paid for it, thus you will incur capital gains tax. A 1031 exchange allows you to defer the capital gains tax. However, there are multiple rules to be aware of. First off, a qualified intermediary (QI) is required in a 1031 exchange. They act as a neutral third party and are the ones who hold the proceeds and facilitate the transaction in accordance with IRS rules. After you sell your property, you have 45 days to identify potential replacement properties. This must be in writing. You must then close on one of those properties within 180 days of the initial sale of your property. Remember that in order to qualify for a 1031 exchange, both properties must be investment properties and the replacement property must be of equal or greater value than the one sold.

When to consider a 1031 exchange?

• You are looking to expand your portfolio: A 1031 exchange allows you to invest in larger properties or multiple properties.
• You have a long-term investment horizon: The tax deferral from a 1031 exchange can have a large snowball effect. You can continue to compound the growth of your portfolio while deferring your taxes.
• You are looking to diversify your assets: You can exchange your property for a different type of property - commercial space, residential home, apartments, etc.

When to consider utilizing both strategies?

In a 1031 exchange, you could receive cash that is taxable. You could use that cash to improve or purchase equipment for your real estate property. You could then utilize bonus depreciation for the equipment to increase your deductions which would help offset the capital gains.

Both strategies can be complex, so always be sure to discuss these with your tax professional.

Have you utilized either of these strategies?