All Forum Posts by: Melanie Baldridge

Reminder:

Ground improvements qualify for bonus depreciation.

This includes various landscaping.

Roads and external parking areas.

Sidewalks and pathways.

Fences.

Utility systems (including the installation or improvements to water, sewage, drainage, and electrical systems).

Outdoor lighting.

Rec facilities (like playgrounds, sports courts, and swimming pools).

And more.

It's a big category for depreciation/bonus depreciation that we love.

A lie:

Bonus depreciation is only for new properties or acquisitions.

The truth:

You can retroactively apply bonus depreciation to property placed in service after September 27, 2017, when the Tax Cuts and Jobs Act passed changing various rules.

The IRS allows you to claim missed depreciation deductions by adjusting your current year's tax return, without needing to amend previous year's returns.

This is typically done through a change in accounting method using IRS Form 3115.

Here are the terms that I’ll define:

-DEPRECIATION

-BONUS DEPRECIATION

-COST SEGREGATION

-BASIS

-LAND VALUE

-IMPROVEMENT VALUE

-3115

-RECAPTURE

DEPRECIATION:

Depreciation is the decrease in $$ value of your asset over time due to wear & tear, etc.

Standard depreciation is deducted evenly over 27.5 years for residential and 39 years for commercial.

Even w/o cost segregation you get to deduct depreciation each year.

BONUS DEPRECIATION:

This is an accelerated depreciation method. It allows a substantial portion of the asset's cost to be deducted in the first year of service.

In 2023, the bonus depreciation rate was 80%.

In 2024, it's 60%.

In 2025, the rate is set to 40% unless the new administration changes it.

COST SEGREGATION:

Cost segregation involves dividing a property into its individual components for tax purposes.

Some parts age faster, like carpets or paint.

Your CPA can use this info to more accurately depreciate elements of your property leading to potential tax savings.

BASIS:

Your basis is the initial price that you paid for your property, including any expenses or improvements.

Knowing your basis is crucial for tax purposes, as it's used to evaluate depreciation & determine the capital gains or losses if/when your property sells.

LAND VALUE:

This is how much your land is worth without any buildings or improvements.

Land doesn't get old like buildings, so you can't depreciate it. But knowing its value is key for taxes.

IMPROVEMENT VALUE:

This is the value of all the upgrades you make to your property – like a new roof or an updated kitchen.

These improvements can be depreciated, which means tax savings for you.

3115:

Filing this form can allow you to claim missed depreciation from past years.

Basically you are letting the IRS know that you are moving from the standard deduction to an accelerated deduction.

RECAPTURE:

It's payback time! If you sell your property, you will likely have to pay back some of the taxes deferred from depreciation.

Think of cost seg as an interest free loan from Uncle Sam - it comes due when you sell the property.

My motto:

Don't let industry jargon stop you from making smart financial moves.

The playbook on how to use real estate to build wealth tax efficiently:

1. Buy with moderate leverage

2. Cost segregate and depreciate initial capital in

3. Stabilize and borrow tax free against your asset

4. Enjoy low tax cashflow year over year

5. Eventually 1031 exchange into a larger asset and repeat

6. Die and step up basis

7. Have your heirs repeat

Many wealthy families do this over and over again and pay little to no taxes as their RE portfolio continues to grow

Do your heirs pay significant taxes?

This is a common question among real estate owners.

Let's dive in:

The reality is that wealthy families often pass on real estate assets from generation to generation.

For example, if one generation has an RE entrepreneur who amasses $50 million worth of real estate, that portfolio can generate enough cash flow to support multiple future generations comfortably when passed on.

So, what happens if that initial investor built their empire by rapidly depreciating assets and using 1031 exchanges to lower the basis and defer taxes along the way?

Do these tax advantages disappear when the original owner passes away and hands the portfolio to their children?

The answer is no, they do not!

The current tax code provides special benefits in this situation.

When the original owner passes away, the "basis" of the assets resets to the market value at the date of death.

In the US, there is currently an estate tax exemption of approximately $13 million per person, which allows the basis to reset, and depreciation can start anew.

This “step-up in basis” is particularly useful if the next generation wants to sell the asset.

Since their basis is set at market value, if the property is sold at that value either at the date of death or within six months, there is no capital gain and no taxable event.

There have been many examples where portfolios of fully depreciated real estate worth tens of millions of dollars have been passed down from one generation to the next, resulting in little to no tax liabilities for their heirs.

Pretty cool, right?

As always, tax laws in the US are subject to change so it's always best to consult with a tax pro or estate planner for the most current and personalized advice.

When thinking about depreciation it's not about when you buy the property, it is when you "put it into service."

When you buy determines your short/long term capital gains.

The "in-service" date = The point in time when you can start taking depreciation from.

This is the simple playbook that tons of Americans have used to build wealth over the last 2 decades:

1. Earn free cashflow from their business.

2. Invest their personal profits into real estate.

3. Do a cost seg study and take bonus depreciation to offset other income. (This works best when you or your spouse are RE pros)

4. End up with a lot of cash and little to no tax each year.

5. Make more money, buy more buildings, and repeat.

These folks have compounded their wealth significantly faster than their W2 counterparts since they don't lose 30-50% to taxes each year.

Warning:

If you depreciate a property down near zero and then have to sell your property at a loss during a situation of distress...

You could end up giving all the proceeds to the bank AND owe the IRS a big chunk of money for recapture.

Long-term tax planning with real estate needs to be coupled with risk management and making sure you don't lose any properties.

In 2025 the bonus depreciation rate is 40%.

This means that if you bought a property for $1M in 2025, did a cost seg study and found $300K in eligible assets that you could depreciate, you could take 40% of that $300K as bonus depreciation to offset your income in the first year.

40% of $300K = $120K.

You then apply that $120K to the owner’s personal tax rate to find the final amount that they can defer in year 1.

If your tax rate is 37%, you can defer $66.6K.

This is a big deal even at the 40% bonus depreciation rate this year.

Imagine making millions of dollars over the course of your career and then having to pay 30-50% every year to uncle sam instead of compounding that cash over time.

This is exactly what real estate professionals have learned to mitigate.

To reduce their taxable income, they just buy a building every year, do a cost seg, and use depreciation to reduce their tax liability dramatically.

Their personal wealth snowball grows much larger and much faster than their W2 counterparts who give most of their money back to the government each year.

Following this strategy as a real estate professional is one of best ways to end up with a much larger net worth at the end of your career.