Cost segregation bonus depreciation: How to save even more in year one

Cost segregation is a fantastic tool for decreasing your tax burden by increasing the amount you can depreciate from your investment properties. But did you know you can save even more with ‘bonus’ depreciation? 

In this article, we’ll explain: 

How depreciation in cost segregation works

Before we get into ‘bonus’ depreciation, we need to make sure you fully understand how normal depreciation works in cost segregation studies.

The federal government assumes that your investment properties lose value every year. They allow you to count that lost value as an expense on your taxes. This lost value expense is called depreciation. Without a cost segregation study, residential properties spread out this depreciation expense over 27.5 years while commercial properties spread it over 39 years. 

With a cost segregation study, you identify each of your building components and figure out which are considered eligible for ‘accelerated depreciation’ by the IRS. This allows you to depreciate components such as appliances, curbs, flooring, etc., at an accelerated period of either 5, 7, or 15 years, if they are eligible. This greatly increases how much depreciation expenses you can add to your tax return earlier on in the life of your property ownership—and helps you save more money faster. 

What is bonus depreciation?

Bonus depreciation is truly a ‘bonus’ on top of your accelerated depreciation. It allows you to take components that are eligible for 5 to 15-year accelerated depreciation and depreciate them at a higher rate in the first year. From 2018-2022, it allowed you to expense 100% of your depreciation in year one, but that number has decreased to 20% for 2023. 

Bonus depreciation came about through the Job Creation and Worker Assistance Act of 2002 as a ‘special depreciation allowance’. Back then, it was introduced at a 30% rate, meaning that you could use the bonus to depreciate 30% of the value of your qualified cost-segregated components in year one. 

In 2017, the Tax Cuts and Jobs Act was passed, which both ensured that bonus depreciation would continue through 2026 and increased it to 100% for 2018-2022. However, it also cut that percentage down to 20% for 2023-2026. While nothing has been passed yet, Congress will likely vote to continue this tax advantage beyond 2026. 

How does bonus depreciation work in cost segregation?

Let’s say we are doing a cost segregation study on a small strip mall that was purchased five years ago for $1,000,000. This property is in an area where the effective income tax rate is 35%. To keep it simple, we’ll say the cost segregation study identified $300,000 that can be depreciated over 15 years and another $300,000 that can be depreciated over 5 years. For fiscal years 2023-2026, you’ll be able to use bonus depreciation to increase your 5 and 15-year components to 20% of the overall value of your property. 

Small Strip Mall – Property value: $1,000,000

In this example, the strip mall owner saves $14,000 on their income taxes by using bonus depreciation in year one. After that, the depreciation will go back to the normal rate, but any extra depreciation taken in year one will not be eligible for year two. Essentially, it’s taking more of the savings from cost segregation upfront, rather than spreading it out. 

Bonus depreciation vs. cost segregation – How do you choose? 

The main factor in bonus depreciation to consider is time. You are taking more of your cost segregation savings in year one as opposed to spreading it out over 5, 7, 15, or more years. 

If you are considering selling the property, then of course it makes sense to depreciate more upfront. Even if you’re planning on holding the property, it can still make sense to take a higher depreciation in the first year because it puts more money in your pocket sooner. You can use that money to invest in other properties, businesses, or stocks, which starts you on a path to more compound growth simply because you had the money sooner. 

The simple answer is: always take more tax savings upfront. You never know if laws will change, if you’ll need to sell the property, or if an opportunity to use your extra money to make more money will come up. 

How to take advantage of bonus depreciation ASAP

To take your bonus depreciation, you’ll need a cost segregation study so you know what components qualify for the first-year bonus. At Commercial Property Refund, we provide fully IRS-compliant cost segregation studies using a proprietary software tool that we designed after doing thousands of these studies ourselves. 

With us, your cost segregation study will be simple, fast, and yield a much higher ROI than standard options. 

Ready to maximize your property’s cash flow? Check out our commercial property refund calculator to get an idea of how much you can save on next year’s tax return. 

About Author

Richard Bourgault

Graduating from Georgia Tech with a degree in Electrical Engineering, Richard has gained over a decade of expereince in Cost Segregation coupled with software UX.

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