We have all heard that the only sure things in life are death and taxes. That is certainly true, but some people are simply not aware that investing in real estate is one way to lower that tax bill. In fact, I left my advertising career last year to pursue real estate investing full time because my investments helped me defer so much in taxes. (Remember, I am not a tax professional. Consult your CPA about your personal situation.)
Most people know that real estate investing can provide cash flow and appreciation, along with other benefits that can be incredibly tax friendly. But due to the 2017 Tax Cuts and Jobs Act, many investors are now able to take advantage of a little-known section of the new tax code called bonus depreciation. Taking advantage of bonus depreciation is tough to do with small properties, but when you buy or invest in large commercial properties, it can be a game-changer.
You see, passive losses can offset passive income, and when you invest in real estate, you are actually required to take something called depreciation against any rental income. That depreciation often results in a paper loss, even though you may have positive cash flow. Depreciation has always been a benefit of real estate investing, but that depreciation was usually required to be spread out over 10–30 years. However, the new tax law allows investors to accelerate that process using what the IRS calls bonus depreciation. Based on the results of a required cost segregation study to identify areas you can accelerate, investors may legally move many depreciating items into year one, instead of spreading those depreciation deductions out over time.
A cost segregation study is expensive, so it only really makes sense when investing in commercial real estate either passively or as a partner. But if a cost seg study is economically feasible, those accelerated losses can be used to offset other passive income. And make no mistake — when you collapse potential deductions from 30 years to one year, the increased amount can be substantial, and can often play a significant role in a household’s net income calculations.
For real estate investors and those who have other income that is defined as passive, bonus depreciation is manna from heaven. Now, losses that you used to have to spread out over many years can be taken in year one, typically resulting in exponentially higher paper losses. If you can’t deduct any or all of those losses in a single year because of your particular tax situation, most of the time you can carry those losses forward to a later date. Since the new tax law might not be renewed upon its expiration, that to me is definitely a reason to invest now instead of later. The benefit may simply not be available down the line.
Because of the expense of a cost segregation study, it really only makes sense when investing in large apartment communities, office buildings, self-storage, etc. In my business, though, most large apartment syndicators are indeed conducting cost seg studies so that small investors have the opportunity to take advantage of this little-known bonus depreciation gift.
The story gets better if anyone in your household is a real estate agent or if they, via other activities, meet the IRS definition of a “real estate professional.” For real estate professionals, those passive losses can offset income from any source, potentially deferring taxes on other income. I know plenty of investors who are paying very little tax because they invested in commercial real estate in 2018, and those losses were able to offset some, or even all, of their spouses’ W-2 income.
It’s not a simple thing to wrap your head around, but there are resources available. Many, many advisors are talking about it, and interested investors should consult their teams to learn more and understand their eligibility for certain tax benefits. In the meantime, happy investing to all.