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Estimating Tax Savings From 100% Bonus Depreciation

Bonus Depreciation Tax Savings

Summary: Every year, Kenji and I come up with a plan to shelter most, if not all of our income through our rental properties. While there are several ways to shelter your income, one of the best ways is to use something called 100% bonus depreciation. Not even sure what I’m talking about? In this post, I build on a previous post where we covered depreciation and 100% bonus depreciation. I then show you our quick back of the envelope calculation to estimate bonus depreciation. Using this calculation, we can ensure that we have enough depreciation losses each year to minimize and even eliminate our income tax burden.


[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]

 

The fact is the US government tax code highly favors real estate investors. 

Like business owners, real estate investors get to write expenses off of income before paying taxes on the reminder. This minimizes our tax burden up front. 

But, in addition, we have an even better tax loophole – depreciation.

We covered depreciation and 100% bonus depreciation in a previous post, but in brief, it’s something that rental property owners use to generate significant paper losses from their real estate. If you have something called Real Estate Professional Status, you can use these losses to shelter W2 or 1099 income.

In this post, we explain how we use a back-of-the-envelope calculation to determine roughly how much depreciation we’ll harvest from a property before we even buy it. We use this calculation almost daily, since it’s what allows us to proactively plan out enough tax losses each year. This allows us to shelter our clinical (and now blog) income.

But before diving into the back-of-the envelope calculation, let’s look at an example to better illustrate how we use this calculation in practice.

 

An example fourplex

Let’s say you put $100,000 down to buy a $400,000 fourplex. Year one, you take 100% bonus depreciation. This means you get $100,000 loss on your taxes (we’ll explain how we got this number below). 

This is a “passive loss,” meaning it shelters only passive income, unless you have Real Estate Professional Status. If you have REPS, then this loss shelters active income.

This is why getting REPS is such a powerful tool to build wealth. It also shows you why Kenji cut down to half-time the first year we started investing in real estate together. We knew the tax savings alone could justify the loss of half of his income. 

Assuming you have REPS then, $100,000 loss saves you about $25,000 in income taxes (assuming a 25% effective tax rate). The government just paid a quarter of your down payment.

Now, you rehab your property (and you can write-off most of the rehab as a loss that year too using bonus depreciation – more tax losses!) and force appreciation of $150,000. Now you sell that same fourplex a year later for $550,000 and roll it tax-deferred, using a 1031 exchange, into another property. This time you have a $250,000 down payment so you can buy a $1 million property.

You take 100% bonus depreciation again. Now you generate yourself a $250,000 bonus depreciation loss. This saves you about $62,500 in income taxes (assuming the same 25% effective tax rate). 

You see the value? You can do the same thing with short-term rentals and commercial properties (like office buildings) too. 

In fact, we recently bought a short-term rental, and took 100% bonus depreciation on it. This generated over $200,000 loss on our taxes between the depreciation and the write-off of the rehab project. You don’t need to meet criteria for real estate professional tax status to create active losses with short-term rentals. 

 

The rough-estimate calculation for 100% bonus depreciation

About now you’re probably wondering how I got those depreciation numbers. That’s an important question, because predicting in advance how much bonus depreciation you’re going to be able to claim prior to even purchasing a property allows you to plan ahead to shelter all of your income that year.

The gold standard for predicting how much depreciation you’re going to be able to claim on your taxes comes from getting a cost segregation study done by an engineering firm. But this takes time, and you certainly don’t get that before you even put in an offer on a property. 

So, here’s the rough calculation Kenji and I use to estimate 100% bonus depreciation ahead of time. 

We estimate 25% of purchase price will be our depreciation loss that first year.

A couple of important caveats to this calculation: 1.) This assumes that you are buying B/C class properties, not A type properties, where a lot of the value is in the land, not the building. 2.) This assumes you are not buying where the land is expensive, such as in California, for example, or a waterfront property. 3.) This assumes you are buying a multifamily property. If you’re buying a single family home, I’d budget less for your bonus depreciation calculations since you don’t have as many depreciable items (i.e. not as many appliances, for example, per square foot). 

 

How do I claim 100% bonus depreciation?

Claiming 100% bonus depreciation takes a few steps. 

You need to pay for a cost segregation study

You should communicate with your accountant closely. This ensures your study and depreciation losses are maximized according to your unique situation. An example: you may consider putting off a cost segregation study and claiming 100% bonus depreciation until a year you know you’re going to meet criteria for real estate professional status.

This reinforces the need for a tax strategist extremely well-versed in real estate investing. 

 

What is the future of bonus depreciation?

100% bonus depreciation ends in 2022. In 2023, bonus depreciation is scheduled to be 80% and then 60% in 2024. 

With changes in administration, these dates may also change. In fact, some real estate investors and accountants hypothesize that 100% bonus depreciation may get completely phased out as early as 2022. 

However, there’s one last pearl of knowledge I want to leave you with. Currently, you can carry forward any bonus depreciation you don’t use in a given year.

For example, let’s say you generate $500,000 in depreciation this year as a real estate professional. If you only have $200,000 in income, you can carry forward your loss of $300,000 to shelter next year’s taxes.

In fact, I’ve met real estate investors who are trying to create enough losses these years with 100% bonus depreciation that they don’t pay income taxes for five years after 100% bonus depreciation phases out.

It’s time for you to get busy generating losses! I know we are!

Have you created massive tax losses using 100% bonus depreciation? Do you have questions about how to use depreciation to shelter your clinical income? If so, join the conversation and follow our general Semi-Retired MD Facebook page, then join our physicians or professionals groups! Don’t forget to get on our waitlist for Zero to Freedom Through Cashflowing Rentals, where we teach you how to go from minimal real estate knowledge to purchasing a portfolio of cashflowing rentals. 

Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD  Facebook page and join our Doctors or Professionals  group!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

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Hi, we’re Kenji and Leti

we provide coaching and mentorship for doctors and high-income earners

Several years ago, we were newlyweds working as full-time hospitalists. On paper, it looked like we had everything: the prestigious careers, the happy marriage, the luxurious rental home, the cars, etc.

But in reality? Despite having worked for several years, we had very little savings. Despite our high income, we had very little freedom in terms of time or money.

One thing was clear: we had to do something.

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