Real estate investing isn’t only about finding the perfect property and collecting rent—it’s also about maximizing your profits and minimizing your tax liability. One of the most powerful benefits of real estate investing is depreciation. Depreciation refers to the gradual loss in value of a property over time, and it’s a critical financial tool that can reduce your taxable liability and help you generate significant income.
However, there’s a major change in the way depreciation works that’s slated to come into effect in the next few years: the bonus depreciation benefits associated with real estate investing will be changing in 2023. In this blog post, we’ll discuss why depreciation is such a valuable asset for real estate investors, and what you need to know to make the most of this benefit before the rules change.
What is depreciation, and why is it so important for real estate investors?
Depreciation is a concept that applies to all assets, including real estate. Essentially, it refers to the gradual decline in value that a property experiences over time, due to natural wear and tear, obsolescence, or other factors. To put it simply, if you buy a property for $1 million and expect to sell it for $1 million in 20 years, you’ll have to account for the $50,000 in depreciation that the property has experienced each year.
So why is depreciation so important for real estate investors? One reason is because it allows you to offset the rental income you earn from your properties with deductions for the depreciation you’ve experienced. This means that each year, you can reduce your taxable liability by the amount of depreciation you’ve claimed. This is particularly valuable when you’re first starting out in real estate investing and may have less rental income to offset any potential tax liability.
How does bonus depreciation work, and why is it changing?
In addition to the standard depreciation benefits that all real estate investors can take advantage of, there are also “bonus depreciation” benefits that enable you to accelerate the rate at which you can claim depreciation. Bonus depreciation rules, which have been in place since 2008, allow you to claim a significant portion of the cost of qualified assets in the property as an immediate expense in the first year of ownership.
For instance, if you’ve just bought a property for $500,000 and $100,000 of that cost is attributed to qualified assets (such as appliances, carpeting, or plumbing), you can claim an immediate deduction of $80,000 (80% of the $100,000 worth of qualified assets), and $20,000 can be depreciated over time, just like other non-qualified assets. This can be a powerful tool for real estate investors who want to maximize their deductions and reduce their taxable liability.
However, the bonus depreciation rules are changing—and not in favor of real estate investors. Starting in 2023, the bonus depreciation amount will be gradually phased out over the next few years, with the percentage dropping to 60% in 2024, 40% in 2025, 20% in 2026, and ultimately reaching 0% in 2027.
How can real estate investors take advantage of bonus depreciation before it changes?
The good news is that there’s still time to take advantage of bonus depreciation benefits before the rules change in 2023. If you’re planning to buy a property in the next few years, it’s worth investing in qualified assets that can be accelerated for bonus depreciation. By investing in these assets now, you can maximize your deductions and reduce your taxable liability in the years leading up to 2023.
It’s also worth noting that bonus depreciation benefits only apply to new assets. If you’re buying a property that already has existing assets, you’ll need to determine which ones are qualified for bonus depreciation and which are not. This can be a complicated process, so it’s usually best to consult with an experienced real estate accountant who can help you navigate the rules.
Real estate investing is a powerful way to generate income and build wealth, but it’s important to remember that smart tax planning is critical to maximizing your profits. Depreciation, including bonus depreciation, is one of the most significant tax benefits associated with real estate investing, but it’s also a benefit that’s rapidly changing. By understanding the rules around depreciation, you can take advantage of this powerful tool before it’s too late. Whether you’re a seasoned real estate investor or just starting out, working with an experienced real estate accountant can help you navigate the complexities of tax planning and investment strategy.
