Let’s talk about pass through depreciation and how it may save you significant taxes in 2020.
With the presidential race being called as a Biden victory, there is still some uncertainty on what the future tax rates and capital gains may look like. As of this writing, it appears the Senate will remain in Republican control. While the Biden Tax plan included the potential of eliminating the lower capital gains rate we feel it is less likely this happens at this point. However, my overall feeling is that it is likely the capital gains rate will go up. This makes depreciation even more important and we will explain below how investors may be able to take advantage of it.
JKAM recently launched its Diversified Real Estate Fund. One of the key benefits of real estate investing is the depreciation of the building; which in many cases can offset all preferred returns that our limited partners may earn.
Cost Segregation Analysis
An interesting opportunity that our partners often take advantage of is completing a cost segregation study which allows for the depreciation benefit to be accelerated.
According to American Society of Cost Segregation Professionals, “Cost segregation is the process of identifying property components that are considered “personal property” or “land improvements” under the federal tax code. The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life than the building”.
The simple explanation of this is when we partner on new building acquisitions we typically do significant work the first year. This can range from installing energy efficient led lighting, more energy efficient heating/air conditioning, water efficient toilets and many other fixtures.
Rather than receiving depreciation over 27.5 years the study allows us to accelerate the depreciation to take a larger amount of it in the first year. What makes this strategy more powerful is the ability to take accelerated depreciation upon acquisition of used buildings, rather than strictly new construction.
The 2017 Tax Cut and Jobs act also temporarily increased the allowance for what is called bonus depreciation from 50% to 100%. This allows items such as appliances, carpet, mechanical equipment as well as landscaping, roof repair, parking lot and other improvements to be depreciated 100% in the first year.
Utilizing These Tax Strategies
A great example of this is our current new investment in Atlanta, Georgia. The project will provide between a 50 and 60,000 tax loss the first year per 100,000 investment. Our fund has made a 500,000 investment into the project which means just this project alone will deliver a 250,000 tax loss this year while generating an overall 17-19% projected return over 5 years.
Here is where the depreciation gets more powerful. If an investor has a 50,000 gain from the stock market this year passively but invests 100,000 into our fund December 30th. They would be an owner and receive their portion of the depreciation for 2020. This could significantly offset their passive income. *Note that there can be complex rules, especially pertaining to your state of residency. We are not providing tax advice and encourage everyone to speak with a tax professional about their individual situation.
Cost Segregation was established by the Supreme Court in 1959, so this is presumably safe from any upcoming tax law modifications. Historically, both the Obama and Trump administration have looked favorably towards Bonus Depreciation. Biden’s administration is likely to keep Bonus Depreciation employed as an economic recovery tool, however it is important to pay close attention to his cabinet selections. Prior to the 2017 Act, only new property qualified for Bonus Depreciation, however, for now used property is eligible. If Biden retains Bonus Depreciation, we could possibly see qualifying assets revert back to new only.
As previously mentioned, there is a perfect storm brewing in distressed assets and our outlook indicates that some of these historic tax benefits likely have an upcoming expiration date. I invite you to reach out and discuss how JKAM may assist you with taking advantage of these passive investment strategies prior to year-end while they are still available.