How to Qualify for Bonus Depreciation on a Rental Property

If you are a real estate investor, then you know that any little edge you can get can make a big difference in your bottom line. That is why it’s important to take advantage of all the tax breaks available to you, including bonus depreciation. But what is bonus depreciation, and how do you qualify for bonus depreciation on a rental property? Here is a quick overview.

What is Bonus Depreciation?

Bonus depreciation is a tax incentive that immediately allows businesses to deduct a large percentage of the price of eligible assets upon purchase, rather than write them off over time. This can be incredibly useful for expensive machinery or other costly business purchases including real estate.

How Does Bonus Depreciation Work? 

Let us say you purchase a rental property for $100,000 in 2020. Normally, you would be able to deduct 3.636% of the cost each year for 27.5 years (i.e., the standard depreciation period for residential rental property). However, because you qualify for bonus depreciation, you can deduct 100% of the cost if the property qualifies.

The Tax Cuts and Jobs Act, passed in 2017, changed the rules on bonus depreciation significantly. Finally, it increased the bonus depreciation allowance for qualified property, as defined by the IRS, from 50% to 100%. The 2017 legislation also extended the incentive to cover used property if certain criteria were met. This rule previously only applied to property that was bought brand new.

The new bonus depreciation rules apply to property acquired and placed in service after September 27, 2017, and before January 1, 2023, at which time the provision expires unless Congress renews it. In 2023, the rate for bonus depreciation will be 80%. In 2024, it will be 60%, and in 2025, it will be 40%. In 2026, it will be 20% (assuming Congress does not change the law before then). Bonus depreciation is available to property acquired before September 27, 2017. The bonus depreciation rate (currently 100%) is multiplied by the cost basis of the acquired asset to determine bonus depreciation calculations.

Qualifying Bonus Depreciation on Rental Property

Qualifying for bonus depreciation on a rental property can save you thousands of dollars in taxes over the life of the investment. To qualify, the property must be placed in service before December 31st of the year in which it was purchased. The eligible property must also be used for business or income-producing purposes; it cannot be used for personal use. If you have any questions about whether your property qualifies, always consult with a qualified tax advisor before making any decisions.

Residential Rental Property Depreciation

The federal income tax code allows investors to reduce the cost of property for the life of the property by a percentage point. The amount of depreciation deducted depends upon the cost of the property, the depreciation methods utilized and the time it will probably be used. The most commonly used depreciation method for rental homes is the straight-line method.  Investors calculate the deduction expense by taking the purchase price of the property and dividing the cost of the property by the years in the useful lifecycle of the property.

How to properly claim bonus depreciation

Many businesses have an accountant and/or bookkeeper on staff, but they may not specialize in bonus depreciation benefits. Though both play an integral role in a business, a Tax Strategist is a key to knowing how to save and stretch money when it comes time to file taxes. Having a tax strategist on your team is a game changer for any real estate investor looking to capitalize on their profits.

Jose A. Ramirez is an experienced tax strategist who helps investors in the Real Estate industry, including those in the activity of Short-Term Rentals such as AirBNB and VRBO, Landlords, Wholesalers, Rehabbers, Flippers, Real Estate Brokers, and Realtors. Schedule an appointment with Jose A. Ramirez for any additional questions you may have about this recent event. Make sure you are subscribed to the Advanced Tax Advisors email list so you can receive current events just like this in the future.