What Is Bonus Depreciation and how Should Property Managers Account for It

Disclaimer: The details below provide broad information on bonus depreciation. For specific and timely advice on tax and financial matters, it’s always a good idea to speak with a certified public accountant or other tax professional familiar with the industry.  

As a property manager, your focus may often be on the day-to-day tasks of managing properties, tenant relations, and keeping everything running efficiently. Yet, there’s a powerful financial concept that could significantly impact the property owners you work with: bonus depreciation.

This guide will break down bonus depreciation, how it operates, and its effects on both property owners and you as a property manager.

Understanding Bonus Depreciation

Bonus depreciation lets property owners immediately deduct a large portion of certain asset costs instead of spreading the depreciation over several years. This offers substantial tax relief in the first year the asset is put into service. While regular depreciation spreads the cost of a property over time (typically 27.5 years for residential properties), bonus depreciation allows a much faster deduction. Under current tax law, property owners can depreciate up to 100% of qualified assets in the year they start using them (if they meet certain criteria).

Difference Between Bonus Depreciation and Regular Depreciation

Regular depreciation spreads the cost of an asset over several years, usually matching its useful life. For example, a residential rental property typically depreciates over 27.5 years. Bonus depreciation, however, allows property owners to deduct a large portion of the cost upfront, reducing taxable income immediately. This is especially valuable for property owners seeking to maximize tax savings quickly.

How Bonus Depreciation Works

Qualified Assets

Not all property assets qualify for bonus depreciation, but certain ones certainly do. For residential property owners, qualified assets generally include:

• Personal property: Items such as appliances, furniture, and equipment used in the rental property.
• Land improvements: Features such as fences, landscaping, and parking lots separate from the building itself.
• Qualified improvement property (QIP): Improvements made to the property’s interior, such as upgrades to plumbing or electrical systems.

The key to bonus depreciation is that it applies to assets with a useful life of 20 years or less. The tax benefit can be significant as owners can deduct 100% of the cost of qualifying assets in the year they are put into service (under current tax law, set to phase down after 2022).

Example of Bonus Depreciation in Action

Imagine a property owner installs new appliances in a rental unit, costing $10,000. With bonus depreciation, the owner can potentially write off the entire $10,000 cost in the same year the appliances are put into service, rather than depreciating them over a longer period.

This accelerated depreciation strategy can be especially helpful for property owners looking to lower their taxable income significantly in the first year, freeing up funds for future investments or expenses.

Impact of Bonus Depreciation on Property Managers

While bonus depreciation primarily affects property owners, it can also have important implications for you as a property manager. Here’s how:

Influence on Property Owner’s Cash Flow and Investment Strategies

When property owners reduce their taxable income through bonus depreciation, they may find themselves with more disposable cash in the short term. This could influence their decisions in several ways:

• Increased Investment: Owners may be more inclined to invest in property upgrades or purchase additional properties due to immediate tax savings.
• Improved Cash Flow: With lower tax liabilities, property owners may have more liquid funds to reinvest in property improvements or meet operational expenses.

As a property manager, understanding these financial movements can help you anticipate potential changes in property management needs. Owners may want to upgrade or remodel properties more frequently or choose to expand their portfolios.

Potential Impact on Property Sales

If a property owner has used bonus depreciation and later decides to sell the property, they may face a tax consequence known as depreciation recapture. This means that any depreciation deductions previously taken will be subject to taxation when the property is sold.

While this doesn’t directly impact the property manager’s daily responsibilities, it’s something you should be aware of if your client decides to sell a property. Depreciation recapture can affect the sale price or timing and may influence the owner’s goals or expectations in managing the property.

Effect on Property Management Costs

In some cases, property owners may want to upgrade or invest in new assets because of bonus depreciation incentives. As their property manager, you may see an increase in requests for renovations or additions that qualify for bonus depreciation. This means you might be tasked with coordinating more capital improvement projects or overseeing renovations that are part of their tax strategy.

Key Considerations and Limitations

Bonus depreciation offers several advantages, but it’s important to be aware of certain limitations and considerations:

Eligibility Requirements

To qualify for bonus depreciation, the asset must be new (though some exceptions exist for used property) and have a useful life of 20 years or less. Property managers should familiarize themselves with the types of assets that qualify for bonus depreciation to help property owners take advantage of this opportunity.

Impact of Changing Tax Laws

Bonus depreciation is subject to change, and it’s important to stay updated on any tax law revisions. For instance, the current provision allowing 100% bonus depreciation is scheduled to phase down. The phase out started in 2023 and will decrease by 20% per year until it reaches 0% in 2027.

While these changes may not happen immediately, they are worth keeping in mind when discussing long-term financial planning with property owners.

Depreciation Recapture

As mentioned earlier, when a property is sold after having benefited from bonus depreciation, the property owner may face depreciation recapture, where they must pay tax on the depreciation deductions they took in previous years. This can lead to a higher tax bill when the property is sold, which might affect the timing of the sale.

Limitations on Taxable Income

Bonus depreciation can be a valuable tool for reducing taxable income, but it is not unlimited. There are rules and thresholds regarding the total amount that can be deducted, and it’s important for property owners to work with a tax professional so that they aren’t exceeding their limits.

Frequently Asked Questions

What is bonus depreciation?

Bonus depreciation is a tax incentive that allows property owners to accelerate the depreciation of certain assets, enabling them to deduct a significant portion of the asset’s cost in the first year of acquisition rather than spreading it out over the asset’s useful life.

Which assets qualify for bonus depreciation?

To qualify for bonus depreciation, the asset generally needs to be new and have a useful life of 20 years or less. However, there are exceptions where certain used properties might also qualify. It’s important to consult with a tax professional to determine eligibility.

What are the potential drawbacks of using bonus depreciation?

One of the potential drawbacks is depreciation recapture, which occurs when a property is sold after having benefited from bonus depreciation. The property owner may face a tax consequence where they must pay tax on the depreciation deductions previously taken, potentially leading to a higher tax bill when the property is sold.