Getting to know the tax benefits is really important if you own real estate. You can eliminate or reduce your federal and state income taxes. Depreciation is something that underpins most of the advantages. In this article let’s understand what depreciation, accelerated depreciation, and bonus depreciation is.
What is depreciation?
Depreciation is the decrease in the asset’s value as and when it gets old. The IRS, for this purpose, allows the owners of the asset to allocate its cost over its life expectancy. Many assets qualify for depreciation. For the most part, the value of real estate appreciates over a period of time, however, depreciation is allowed and as per the IRS. The useful life of an asset that is occupied by a resident is 27.5 years.
Let’s take a look at how it works
Let us assume you purchased a building for 4.5 million dollars and the value of the land is around 8,50,000 dollars. Coming to the concept of depreciation, land cannot be depreciated, however, the building can. So, deducting the value of land from the purchase price, we get 36,50,000$. Thus, dividing 36.5 million dollars by 27.5 years we get $1,32,727 as depreciation for each year for the upcoming 27.5 years.
This is straight-line depreciation. Straight-line depreciation is a method of calculating depreciation where the value of a fixed asset is reduced gradually over its useful life. A lot of real estate owners take maximum benefit in the early years of ownership. We require a cost segregation study to be performed for accelerated depreciation. Taking the above example into consideration. A cost segregation specialist would first perform a study on the property and differentiate the structural and non-structural elements. The structural elements in general are depreciated over a period of 27.5 years. Items like carpets, furniture and fixtures, and land improvements that include parking lots, swimming pools, etc, come under personal property and these items are usually depreciated over a period of 5, 7, or 15 years. By doing this the owner of the property gets more depreciation in the early years of ownership.
Bonus depreciation is a valuable tax-saving tool that allows your business to take an immediate first-year deduction on the purchase of your business property. This is highly beneficial and in recent times bonus depreciation has taken it to a new high. Property owners, if your property was acquired after September 27, 2017, you can take the complete benefit in year one. You are no longer required to delve into the concept of 5, 7, or 15 years, it can all be done in year one.
Tax benefits – The bottom line
Real estate investors have always benefited from tax savings. Now the Tax Cuts and Jobs Act and bonus depreciation have brought in a lot more benefits. The benefit of bonus depreciation is likely to last throughout 2022 and then move to 20 percent a year from 2023 to 2026. If not renewed, it is likely to vanish in 2027. If you are looking to pay less on taxes, then it is better to take advantage of bonus depreciation.