$1,000,000 of equity, three ways
Depreciation is based on what the property costs, not what you put in. Pair a cost segregation study with typical commercial leverage and the same equity supports a much larger depreciable base.
| All cash, straight-line | All cash + cost seg | 60% leverage + cost seg | |
|---|---|---|---|
| Equity invested | $1,000,000 | $1,000,000 | $1,000,000 |
| Loan | $0 | $0 | $1,500,000 |
| Depreciable basis | $1,000,000 | $1,000,000 | $2,500,000 |
| Reclassified to 5-, 7-, 15-year property (30%) | $0 | $300,000 | $750,000 |
| Year-one depreciation deduction | $25,641 | $317,949 | $794,872 |
Illustrative and simplified. Assumes the full purchase price is depreciable building basis (land is not depreciable, so real numbers are lower), a hypothetical 30% reclassification (often in the 30–35% range, but it varies by property), and ignores mid-month convention and state treatment. Not a projection of investment results. Leverage also increases risk, including the risk of loss. Depreciation is largely a deferral: it lowers your basis, and recapture and gain apply at sale. Your ability to use these deductions depends on the passive activity, at-risk and basis rules and your own situation.
Deferred tax is money that stays invested. Dollars that would have gone to the IRS this year can be reinvested and keep working for you, until recapture and gain come due at sale.
Sold a deal this year? Expect to next year?
This is where bonus depreciation does the most work for passive investors.
Gain this year
Losses from a new investment can typically offset passive gains from exiting another passive real estate deal in the same tax year.
Gain next year
Passive losses you can’t use now generally carry forward and can offset future passive gains, including an exit you expect next year.
Work with a CPA first
Timing, the character of the gain (including recapture) and how the investment is structured decide whether the losses line up. Plan it with your CPA before you invest, not in April.
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