Depreciating Your Commercial Property + The Tax Cuts & Jobs Act of 2017
Depreciation in commercial real estate is a fundamental principle that allows property owners to recover the cost of their investment over time. The Tax Cuts and Jobs Act of 2017 (TCJA) also brought about some changes that significantly benefit those who invest in commercial real estate.
Depreciation in Commercial Real Estate
Definition: Depreciation is the allocation of the cost of a property (excluding land) over its useful life. The idea is that assets, such as buildings, wear down and lose value over time, so this cost can be deducted from your taxable income.
1.) Tax Benefits: Commercial real estate owners can deduct a portion of the property’s value each year, reducing their taxable income. This can result in significant tax savings.
2.) Depreciation Methods: The two common methods used for depreciation are Straight-Line Depreciation and Accelerated Depreciation. Most commercial properties are depreciated over 39 years using the Straight-Line method (Residential properties in the United States are typically depreciated over 27.5 years).
3.) Section 179 Deduction: For certain improvements, like roofs, heating, ventilation, and air conditioning (HVAC) systems, the TCJA allowed for an immediate write-off under Section 179, which was previously a gradual depreciation.
How the Tax Cuts and Jobs Act of 2017 Affects Commercial Real Estate Investors
1.) Bonus Depreciation: The TCJA introduced 100% bonus depreciation for certain assets, which includes many improvements to commercial real estate, such as interior improvements, roofs, and HVAC systems. This provision allows investors to write off the entire cost of these improvements in the year they are made, instead of spreading them out over several years (investors can commission a cost segregation study from an engineering firm. This study will pinpoint different components of a property eligible for accelerated depreciation). This is a significant tax advantage. However, this provision is set to decrease gradually over time, so buying sooner means you can take full advantage of this benefit before it potentially phases out.
– The bonus rate will decrease by 20 percentage points annually for property put into service after December 31, 2022, and prior to January 1, 2027. See the following schedule:
2022: 100%
2023: 80%
2024: 60%
2025: 40%
2026: 20%
2027: 0%
2.) Reduced Tax Rates: The TCJA also lowered individual and corporate tax rates, leaving investors with more after-tax income, which can be reinvested or used for additional property purchases.
3.) Pass-Through Deduction: The TCJA introduced a 20% deduction for qualified business income from pass-through entities. Many real estate investors structure their investments as pass-through entities, such as LLCs, which can potentially reduce the effective tax rate on rental income.
4.) Like-Kind Exchanges: The TCJA preserved the 1031 like-kind exchange provision for real estate. This allows investors to defer capital gains taxes when they sell a property and reinvest the proceeds into another like-kind property.
5.) Interest Deduction Limitation: The TCJA introduced limitations on the deductibility of interest expenses for businesses. However, it did provide exceptions for real estate businesses, allowing them to continue to deduct a significant portion of their interest expenses.
Overall, the Tax Cuts and Jobs Act of 2017 has generally been favorable for commercial real estate investors. The immediate expensing of certain improvements through bonus depreciation, reduced tax rates, and the preservation of like-kind exchanges have provided investors with greater tax incentives and opportunities for building wealth through real estate investments. However, tax laws are complex, and it’s essential for investors to work with tax professionals who specialize in real estate to ensure they take full advantage of these benefits while staying compliant with the law.
Disclaimer:
VANDEWEERD COMMERCIAL does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
