Generally speaking, the purchase price of your investment real estate asset is “capitalized.”  The IRS then allows you to deduct or write off the “basis” of the asset over a set period of time, either 27.5 years or 39 years.  This is referred to as “depreciation” or capital recovery.

While this is nice, one should consider the effects of spreading out 100% of the price over 39 years when it comes to inflation.  For example, if your investment property was $1,000,000 and you did nothing, you would receive a $26k deduction per year. Not bad?

Well, the value of $26k today is not the same as it will be in 20 years, especially with inflation.

What can you do?

• This is why our team LOVES real estate.  It's flexible, there is a lot you can do.  When it comes to inflation, we want to find ways to speed up or accelerate all real estate deductions. 

• We will briefly touch on a few topics and follow up with deeper dives in a future series.

1) Cost Segregations

• The easiest way to explain cost segregations is to look around you, right now (if you are at home or in an office).  What do you see?  Certainly not all walls and floors (unless you are reading this from jail).
• A cost segregation divides the price of the asset between very specific asset classes, such as putting a value on the windows, doors, lights, electric wiring, plumbing, fixtures, furniture, appliances and the list goes on!
• Why does this matter?  Well, all of those things have SHORTER depreciation lives than 27.5 or 39 years. If you perform a cost segregation study, you can now accelerate a deduction that otherwise would have taken up to 39 years to fully realize.

2) Temporary 100% “Bonus” Depreciation  

• To make this even better, any of the items that are reclassified from a cost segregation study to 3, 5, 7, or 15 year “lives” in the tax code can be 100% written off in the current year (through 2022).  After 2022, this phases out over several years, but is still very beneficial.
• Example: $1,000,000 purchase.  You do nothing and have a nice $26,000 deduction per year. 
• In year 2, you read this blog and realize there is a better way!  You perform a cost seg study and a typical result is as follows:
  • $300,000 of the $1,000,000 falls into shorter lives and you elect to use 100% Bonus Depreciation.
  • You now have a $300,000 deduction THIS YEAR!  Note - very complicated and specific rules apply to know whether this can offset other items such as W2 or K1 income (a topic of which we will have a future series). 

3) Partial Asset Dispositions 

• Another beneficial feature of a cost segregation study is the ability to now write off items you are disposing of.  For example, after 6 years, you need to replace all of the windows of your 4 unit building.  Without a cost seg, you simply remove them and then capitalize the cost of the new windows.
• With the cost seg, you can now write off the remaining cost basis of the items you are tossing out!  If the windows had $5,000 of basis remaining, you can immediately claim that deduction!  

No matter how you run your business, there are always times where capital investments are necessary.  From something as small as computer equipment to as large as commercial trucks or machinery, these investments have important tax implications.  When inflation is rising, we need to be careful “spreading out” these deductions over several years if there are alternative ways to capture the deductions NOW.  Remember, the $5,000 deduction from cash you spend in 2022 will be worth far less in 2026!

1) Understand the “de minimis” safe harbor - As a business owner, by making a specific tax election, you can easily write off any equipment with a value of $2,500 or less in the first year, no questions asked!  Gone are the days of depreciating a computer or small equipment over 5 years.  

2) Understanding Leverage with Business Asset Purchases - Leverage, even with rising interest rates, can be a powerful tax strategy and tool. Let’s illustrate this with an example:

You intend to purchase a $50,000 truck in December for 100% business use in 2022. The car dealer offers a 5 year loan with 4% interest and $0 down payment or a 5 year loan with a $10,000 down payment and a 3.5% interest loan. 

• Option 1:
  • $5250 of tax deductible interest paid. 
  • After a 25% tax rate, effective $3938.  
  • You realize that this business auto qualifies for 100% BONUS depreciation even though you literally put $0 down!
  • Results:
    • Cash out of pocket: $0
    • Tax Deferral Savings from Depreciation: $12,500
    • Cash Positive Savings to Reinvest in Year 1: $12,500

• Option 2:
  • $3660 of tax deductible interest paid. 
  • After a 25% tax rate, effective $2745.
  • Same 100% bonus depreciation is taken
  • Results: 
    • Cash out of pocket: $10,000
    • Tax Deferral Savings from Depreciation: $12,500
    • Cash Positive Savings to Reinvest in Year 1: $2,500

 As you can see with Option 1, from a mere $238 more of interest per year, using leverage means you can have $10,000 MORE to invest in your business or another asset class. This could grow to $15,000 after 5 years, clearly putting you ahead!

3) Bonus Depreciation - Similarly with Real Estate, any 3, 5, 7, 15 year asset you purchase is eligible for 100% BONUS depreciation through 2022 and 80% in 2023.  Take advantage of this!  Buy your assets, with financing, this year to take advantage of this and utilize TVM (time value of money) with inflation. 

4)  IRC 179 - Also known as immediate expensing, this is very similar to bonus depreciation.  The main difference is you cannot use IRC 179 to bring your income “below 0.”  However, this has and will continue to be an important code section for “personal property” assets. 

As a business owner or real estate investor, it is important to always be looking for ways to maximize the return on your investment. 

Although inflation is unavoidable, being aware of and utilizing options that can accelerate your deductions is essential to realizing that return now when it is worth more than it would be down the road.

If you are interested in learning more about how you might be able to speed up the depreciation of your real estate or capital assets, reach out to your GO CPA Team in Soraban!  

Stay tuned for our coming series on Real Estate in which we will also explore how to combine real estate with your operating business for greater tax efficiency!