In this week’s edition, we'll explore a key advantage of investing in Real Estate, specifically in Manufactured Housing Communities (MHCs) and Recreational Vehicle (RV) Parks. Investors can utilize Bonus Depreciation, a powerful tax-saving tool allowing property owners to deduct a significant portion of their costs in the year assets are put into service. By accelerating the depreciation timeline, investors can enjoy immediate tax savings, reducing their taxable income and overall tax liabilities. This strategy allows investors to defer taxes while earning substantial returns.

The image below represents a range of bonus reclassification % by Real Estate Asset Class. You will notice that MHCs often enjoy 2-3 times the bonus depreciation benefits as compared to the others.

Let's dive into how this strategy works.

Understanding Depreciation

Depreciation

Depreciation is the gradual deduction of an asset's initial expense against taxable income over its lifespan. For residential properties, this period usually spans 27.5 years, while for commercial properties like offices, retail malls, and industrial buildings, it extends to 39 years. Depreciation allows investors to annually deduct around 2.6%-3.6% of the asset's purchase price as a depreciation expense against their income.

Cost Segregation

To enhance depreciation benefits, property owners often conduct cost segregation studies to identify specific components eligible for accelerated depreciation. This allows certain assets like landscaping, paving, fencing, and various electrical, mechanical, and plumbing connections to be depreciated faster than the standard 27.5 or 39 years. Some assets follow 5-year schedules, while others span 15 years. Note that land does not depreciate.

Bonus Depreciation

In most cases, investors will complete a cost segregation study to maximize the benefits of bonus depreciation. Bonus depreciation, essentially "depreciation on steroids," allows investors to deduct a significant portion of an asset's cost in the first year it's put into service, applying to items with depreciable lifespans of 20 years or less. This accelerated form of depreciation is particularly advantageous for MHCs and RV Parks, where it's not uncommon for 40%—60% of the property’s value to qualify.

Bonus Depreciation In Action

Let's illustrate how it works with a simple real-life example. Say you purchase a MHC for $1 million, with a non-depreciable land value of $200,000, leaving $800,000 eligible for depreciation.

• After conducting a cost segregation study, it is determined that you can claim bonus depreciation up to $600,000 in which 60%, or $360,000, can be taken in Year 1.
• The property generates a cash flow of 10%, equivalent to $100,000 in net earnings before depreciation.
• In Year 1, the property produces a net taxable loss of $260,000. For passive investors who do not qualify as Real Estate Professionals, this loss can be used to offset other passive income. It’s important to note that this concept applies in Real Estate syndications where investors collectively pool their funds with a General Partner (GP) for a property acquisition.

While passive losses generated through depreciation cannot offset active income like W-2 earnings, they can be used to offset gains from other real estate properties or passive income. It’s no surprise that these asset classes are among the favorites of individuals with multiple income streams.

Latest on Bonus Depreciation

The Tax Cuts and Jobs Act (TCJA), enacted during the Trump administration, increased bonus depreciation to 100% from late 2017 to 2022. This means investors could potentially deduct up to 100% of eligible asset costs in the first year, providing a substantial tax benefit. Bonus depreciation has a sunset provision in which it steps down by 20% each year after 2022. In 2024, it is currently at 60% and scheduled to go down to 40% in 2025.

In late January, the House approved a bipartisan bill aiming to extend key provisions of the 2017 TCJA—the proposed legislation known as the Tax Relief for American Families and Workers Act of 2024. If approved by the Senate and signed into law, this bill would allow real estate investors to continue claiming 100% bonus depreciation. Moreover, it would increase the limit for expenditure on depreciable business assets and potentially enable a higher deduction for business interest expenses.

Conclusion

In conclusion, utilizing bonus depreciation and conducting cost segregation studies offer real estate investors powerful strategies to minimize tax burdens and boost investment returns. These methods serve as effective ways to free up capital, which can be reinvested in future opportunities or utilized to pay off high-interest debt.

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Greenside Gazette

Market Trends

A recent article by Northmarq highlights the manufactured housing market. In 2023, the market saw growth in occupancy rates and rental opportunities. Occupancy rates rose to 94.7%, with notable gains in the Midwest and Southwest. Rents increased by 1.5% in Q4 2023, with a 7.3% year-over-year growth, averaging $679 per month. Cap rates remained stable compared to multifamily assets, averaging 6.5% by year-end, with slight increases in four- and five-star MHCs. Despite challenges, such as potential regulatory issues, the market is expected to thrive in 2024. With healthy occupancies, growing rents, and stable cap rates, investors are drawn to manufactured housing, aided by various financing options.

Source: Northmarq. (2024, April 29th) Trends in the Manufactured Housing Community Sector: Unlocking Opportunities for Investors. https://www.northmarq.com/insights/research/trends-manufactured-housing-community-sector-unlocking-opportunities-investors

Birdie Basics

Section 179 Deduction: Section 179 Deduction is a tax provision enabling businesses to deduct the entire purchase price of qualifying equipment and/or software acquired or financed during the tax year, within specified limits.

Depreciation Recapture: Depreciation recapture is recognizing and including in taxable income any previously claimed depreciation deductions when selling or disposing of an asset at a gain.

*While we strive to provide accurate and up-to-date information, our newsletter content is for informational purposes only and should not be construed as professional tax advice. We recommend consulting with a CPA or tax advisor before implementing any of these strategies.*

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