Bonus Depreciation

What Is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows real estate investors to deduct a significant percentage of the cost of qualifying property components in the first year of ownership, rather than spreading those deductions over the standard depreciation schedule. Originally designed to stimulate business investment, bonus depreciation has become a cornerstone of real estate tax strategy, particularly when combined with cost segregation studies. The provision applies to property with a recovery period of 20 years or less, which includes the 5-year, 7-year, and 15-year property categories identified in a cost segregation study.

The Phase-Down Schedule

Under the Tax Cuts and Jobs Act of 2017, bonus depreciation was set at 100% for property placed in service from September 2017 through 2022. It has been phasing down by 20% per year since then: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027 unless Congress extends or modifies the provision. This phase-down means the urgency of leveraging bonus depreciation increases each year. Check current legislation as Congress may adjust these percentages — tax law changes are common and can retroactively affect bonus depreciation availability.

Creating Massive Paper Losses

When combined with cost segregation, bonus depreciation can generate enormous first-year deductions. On a $2 million apartment building where cost segregation identifies $600,000 in components eligible for accelerated depreciation, the first-year bonus depreciation deduction alone could be hundreds of thousands of dollars at the applicable rate. This paper loss does not represent an actual cash loss — your property may be cash-flowing positively while generating a tax loss. For investors who qualify as real estate professionals, this paper loss can offset W-2 income, potentially eliminating their tax liability entirely in the year of acquisition.

Who Benefits Most

Bonus depreciation is most valuable for investors in high tax brackets who can fully utilize the deductions. If you qualify for real estate professional status, you can apply these losses against active income — making bonus depreciation a game-changer for high-earning households. Even without REPS, passive losses from bonus depreciation carry forward and offset future passive income. Investors acquiring multiple properties in a single year or making large acquisitions see the greatest absolute benefit. The strategy is less impactful for investors in lower tax brackets or those without sufficient income to absorb the deductions.

Strategic Timing Considerations

Given the phase-down schedule, timing your acquisitions to maximize bonus depreciation can significantly impact your after-tax returns. Some investors accelerate purchases into the current year to capture a higher bonus depreciation percentage. Others time cost segregation studies to align with years of high income. If you are closing on a property late in the year, placing it in service before December 31 captures a full year of bonus depreciation even if you only owned the property for a few weeks. Discuss timing strategies with your CPA well before closing — these decisions can save or cost you tens of thousands of dollars.

Bonus depreciation is a powerful but time-limited tool. As the percentages phase down, each year represents a decreasing window of opportunity. For investors who understand and leverage it properly, bonus depreciation combined with cost segregation can provide tax savings that materially improve investment returns and accelerate portfolio growth. Consult with a real estate-specialized tax advisor to determine the current rates and how they apply to your specific situation.