As part of the updated 2018 Tax Cuts and Jobs Act (TCJA), bonus depreciation for Commercial Real Estate (CRE), currently at 80%, will drop to 60% on January 1, 2024.
As you look towards year-end 2023, every real estate investor needs to evaluate how taking the 80% deduction this year or combining it with Section 179 could impact your federal and state tax returns, depending on where you file.
Please note that this article is not legal tax advice. It is purely informational about the different tax options. Consult your CPA or go to the IRS’s website for more.
What is Bonus Depreciation?
The Internal Revenue Service (IRS) bonus depreciation tax code allows business taxpayers to deduct additional depreciation for the cost of qualifying new or used business property (excluding real property) in the year it was placed into service, beyond normal allowances.
Between September 27, 2017 and December 31, 2022, qualifying business property could claim 100% bonus depreciation.
What is “Qualifying Business Property” for Bonus Depreciation?
Business property that qualifies for bonus depreciation must be purchased from a non-family member (not inherited) for “first use,” have a useful life of 20 years or less, and be new to you, the business owner. A few items that may qualify include machinery and equipment, listed property such as vehicles, and depreciable computer software.
As for commercial real estate and triple net “NNN” lease property ownership, the leasehold improvement is one large expense that may qualify.
Qualified Improvement Property: Bonus Depreciation on Leasehold Improvements
A leasehold improvement or a “qualified improvement to the property” (QIP) is any improvement made to an interior portion of a nonresidential building already placed in service. A cost segregation study (CSS) can be used to identify the depreciation of leasehold improvement property.
In order for an improvement to be considered a ‘qualified improvement’ the following three conditions must be satisfied:
- The improvement must be made under a lease by the lessee, sub-lessee, or lessor of that portion.
- The portion must be set for occupancy by the lessee or sub-lessee.
- The improvement must be placed in service more than three years after the date the building was first placed in service.
Qualified leasehold improvement does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building.
Bonus Depreciation Phase-Out Schedule
Under the 2018 Tax Cuts and Jobs Act, the bonus depreciation phase-out schedule is as follows:
- 2022: 100%
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
For in-depth details of the tax code and deduction amounts, please see the IRS’s bonus depreciation rules here.
How is Bonus Depreciation Different from Section 179 Tax Deduction?
The Internal Revenue Code (IRC) Section 179 tax deduction allows a business to expense the full purchase price or a portion of the cost of qualifying tangible personal property, such as machinery and equipment purchased for use in a trade or business, and if the taxpayer elects, qualified real property purchased during the tax year up to $1 million with the phase-out threshold at $2.5 million.
Section 179 allows qualified improvement property and some improvements to nonresidential real property, such as roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems to be depreciated.
Using the Section 179 tax deduction, a business can deduct whatever amount it chooses (within the thresholds) in any given year and allocate the deduction among assets according to preference. This section of the tax code will not phase out.
Bonus depreciation, on the other hand, will phase out. It is not subject to an annual dollar limit or limited to annual business profit, and a business must deduct the full bonus percentage — 80% in 2023 — for all qualifying property in the same tax year, leaving no depreciation remaining for future years.
Jason Simon, Westwood Net Lease Advisor Vice President, suggests “when using both bonus depreciation and IRC Section 179, a cost segregation study (CSS) is a valuable tool. We often recommend it to our triple net lease investors to support property tax depreciation with documentation, maximize the benefit, and potentially claim missed deductions back to 1987.”
Can You Use Both Deductions?
Sometimes one asset qualifies for both Section 179 expensing and bonus depreciation. In that case, you can choose to use one or both tax codes. If you claim Section 179 and bonus depreciation for the same property, IRS rules require Section 179 to be used first, then bonus depreciation, followed by regular depreciation, depending on the property and your unique situation. Your CPA will be able to guide you in this complex tax scenario.
If you have tax questions or would like a referral to a reputable tax specialist or highly accredited CSS professional before you file your 2022 taxes, Westwood Net Lease Advisors can connect you with our vast network with established industry relationships to help you get the solutions you need.
Take Advantage of 80% Bonus Depreciation before December 31, 2023
Not sure if claiming 80% bonus depreciation is beneficial to your business? You have just a few months to decide before 80% deduction ends, reducing to 60% beginning January 1, 2024. To work out the tax code and deductions unique to your business and to determine if a bonus depreciation benefit pertains to your business at all, we recommend you meet with a tax professional as soon as possible to learn the pros and cons and if the 80% bonus depreciation is right for your business in 2023.
If you’re in the commercial real estate or triple net lease buying process, before you purchase, Westwood Net Lease Advisors can make a CSS part of your initial analysis to determine if claiming bonus depreciation or cost segregation depreciation makes sense for you and if the purchase is worthwhile for your financial and tax needs. To learn more, contact us today at 314-997-5227.
Please note that this article is not legal tax advice. It is purely informational about the different tax options. Consult your CPA or go to the IRS’s website for more.
