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The Blackbox Guide to Demystifying Regular Depreciation and Bonus Depreciation

A. Chris Ostler, CPA

January 4, 2023

Cost Segregation is a highly advantageous tax planning strategy that allows companies and individuals alike who have either constructed, purchased, inherited, expanded or remodeled any kind of income producing commercial real estate to increase cash flow by accelerating depreciation deductions and reducing their federal income taxes. To supplement accelerated depreciation deductions, bonus depreciation is also used to maximize tax savings.

When demystifying regular depreciation from bonus deprecation it is important to first understand cost segregation from bonus depreciation. An engineered-based cost segregation study identifies and reclassifies real property assets into personal property assets to shorten the depreciation time, which accelerates depreciation expense and reduces current income tax liabilities. Personal property assets include a building’s non-structural elements, exterior land improvements and some indirect construction costs. The primary objective of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life (typically 3, 5, 7 and / or 15 years) than the building itself. Personal property assets found in a cost segregation study generally include items that are affixed to the building but do not relate to the overall operation of the building. Land Improvements generally include items located outside a building that are affixed to the land. Land improvements include parking lots, driveways, paved areas, site utilities, walkways, sidewalks, curbing, concrete stairs, fencing, retaining walls, block walls, car ports, dumpster enclosures, and landscaping. Shortening tax class lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow. The tax savings from the deduction will depend on the taxpayer’s income tax bracket and individual financial circumstances. However, the savings can be significant.

In contrast, bonus depreciation is an accounting method that allows taxpayers to write off a percentage of the cost of specific assets in the year the property is placed into service. The purpose of bonus depreciation is to encourage taxpayers to invest in new property, plant, and equipment-based assets. It in essence affords businesses a tax deduction to tax effect their cost of their purchase. While the rules change yearly, bonus depreciation is currently available for both new and used equipment. The amount you can write off depends on the type of asset.

To claim bonus depreciation on a tax return, businesses must meet certain requirements under the tax laws. For instance, the asset must be placed in service by the business. So if a taxpayer purchased new equipment in 2022, but the asset is not placed into service until 2023, the taxpayer would not be eligible for bonus depreciation in 2022. However, the taxpayer would be eligible to take bonus depreciation in 2023 when the asset is placed into service.

Currently, you can only use bonus depreciation on assets that typically use MACRS depreciation with less than a 20-year class life. This includes all personal property (3-, 5-, or 7-year property) and land improvements (15-year property). The tax laws govern the amount of bonus depreciation that a taxpayer can take in any given year, which is subject to change. For example, in 2022, the maximum amount of bonus depreciation that a taxpayer could take was 100%. Bonus depreciation phases out over the following four years, dropping to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. After 2026, bonus depreciation will sunset out and no longer be available.

Schedule your complimentary consultation today to demystify the depreciation laws.

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