Recent Tax Changes

The Tax Cuts and Jobs Act of 2017 contained important changes to existing tax law. A provision dealing with “bonus depreciation” provides multifamily investors, among others, the ability to substantially reduce their tax burden immediately (in the year of acquisition) by simply acquiring a multifamily asset. This law remains in effect for properties acquired through December 31st, 2022.

Invest $4 million cash and borrow $16 million to acquire a multifamily property in 2021 and potentially reduce your 2021 tax bill by almost $2 million.

MULTIFAMILY REAL ESTATE DEPRECIATION EXPLAINED

A residential investment real estate asset is typically depreciated over a 27 ½ year schedule. The cost of the improvements (exclusive of land) is divided by 27.5 and this is deducted each year from taxable income. This is known as “straight line” depreciation.

While “real estate” in the strict sense is not eligible to be depreciated using an accelerated schedule, certain systems and components attached to the real estate can be depreciated over a shorter schedule, typically 5,7 or 15 years. These items can include:

THIS CHANGED per the 2017 Act. Through December 31, 2022, these items are now eligible to be depreciated 100% in the year of acquisition. This is called BONUS DEPRECIATION.

The collective value of these components for a residential real estate asset can equal 20% to 40% of the Total Cost of the asset. To access these tax savings, prior to or post-closing, a study called a “Cost Segregation Analysis” is conducted by an accredited accounting firm to categorize and value each system eligible for Bonus Depreciation.

Note that normal straight-line depreciation is still allowed in addition to the accelerated Year One Bonus Depreciation (hence the term “Bonus”).

Since depreciation reduces your cost basis, taxes are generally deferred until sale but not eliminated. However, if a Section 1031 transfer is utilized upon sale of the Property, the tax may be again deferred until you sell the second property, which can be transferred yet again using a Section 1031 Exchange and so on.

And for most investors, there may also be actual tax savings rather than just deferral. This is because many wealthy investors’ top marginal tax rate (37%) is higher than the rate at which the accumulated depreciation is taxed upon sale (currently 25%). If the Property is sold for example at the end of Year One and no tax mitigation strategy is employed, total taxes saved (versus deferred) would equal the difference between 25% of $4,800,000 and 37% of $4,800,000 or $576,000. *All investors should consult a qualified tax professional with respect to their specific tax situation*.