Jun 5th 24

Accelerated Depreciation for Single Family Rental Properties in 2024

As a real estate investor, you're always looking for ways to maximize your returns and minimize your tax liability. One powerful strategy that can help you achieve both goals is accelerated depreciation.

By leveraging this tax strategy, you can potentially unlock significant cash flow in the early years of owning a rental property, giving you more capital to reinvest and grow your portfolio.

In this article, we'll dive into the mechanics of accelerated depreciation for single family rental properties, exploring how it works and the potential benefits it can offer savvy investors like you.

What is Accelerated Depreciation for Single Family Rental Properties?

Accelerated depreciation is a tax strategy that allows real estate investors to front-load depreciation deductions in the early years of owning a rental property. This means you can deduct a larger portion of the property's value as an expense sooner, reducing your taxable income and potentially increasing your cash flow.

Normally, residential rental properties are depreciated over a standard period of 27.5 years, with the depreciation expense spread evenly across that time frame. However, by conducting a cost segregation study, you may be able to identify certain components of the property that can be depreciated more quickly, such as appliances, flooring, or even land improvements.

Example of Accelerated Depreciation

Let's say you purchase a single family rental property for $200,000. Typically, you would depreciate this property evenly over 27.5 years, resulting in an annual depreciation expense of around $7,273.

However, after conducting a cost segregation study, you discover that $30,000 of the property's value can be attributed to assets that qualify for a shorter depreciation period, such as:

Appliances: $10,000 (depreciated over 5 years)
Carpeting and flooring: $12,000 (depreciated over 5 years)
Landscaping and land improvements: $8,000 (depreciated over 15 years)

By separating these assets and depreciating them over their respective shorter time frames, you can claim a larger depreciation expense in the early years of ownership. For instance, in the first year, you could potentially claim:

$2,000 in depreciation for the appliances ($10,000 / 5 years)
$2,400 in depreciation for the carpeting and flooring ($12,000 / 5 years)
$533 in depreciation for the landscaping and land improvements ($8,000 / 15 years)
$6,182 in depreciation for the remaining property value ($170,000 / 27.5 years)

This results in a total first-year depreciation expense of $11,115, which is significantly higher than the $7,273 you would have claimed under the standard depreciation method. By front-loading these deductions, you can reduce your taxable rental income and potentially increase your cash flow in the crucial early years of ownership.

Tax Deferral Through 1031 Exchanges

Accelerated depreciation can be particularly advantageous for investors planning to sell a rental property in the future. When you sell a property that has been depreciated, you may face depreciation recapture taxes on the accumulated depreciation claimed over the years. However, by utilizing a 1031 exchange, you can defer paying these taxes by reinvesting the proceeds into a like-kind investment property.

Timing is key: To successfully execute a 1031 exchange, you must identify the replacement property within 45 days of selling your original rental and complete the purchase within 180 days.
Defer taxes, maintain momentum: By deferring the depreciation recapture taxes and capital gains taxes through a 1031 exchange, you can keep more of your profits working for you in your new investment, allowing you to continue growing your rental property portfolio without the immediate tax hit.

Potential Drawbacks of Accelerated Depreciation

While accelerated depreciation offers significant benefits, it's essential to understand the potential drawbacks as well. One key consideration is that claiming larger depreciation deductions early on will result in a lower depreciation expense in later years. This means that your taxable rental income may be higher in the future, as you'll have less depreciation to offset it.

Additionally, the cost segregation study required to identify assets for accelerated depreciation can be expensive, especially for smaller rental properties. Investors must weigh the upfront cost against the potential tax savings to determine if it's a worthwhile investment.

How Does Accelerated Depreciation Work for Single Family Rentals?

Accelerated depreciation allows real estate investors to maximize their tax deductions in the early years of owning a rental property. This strategy involves identifying components of the property that can be depreciated over a shorter time frame than the standard 27.5 years for residential rental properties.

To take advantage of accelerated depreciation, investors can conduct a cost segregation study. This study analyzes the property to determine which components qualify for shorter depreciation periods. Examples of items that may be eligible for accelerated depreciation include:

Appliances: Refrigerators, stoves, and other appliances can often be depreciated over a 5-year period.
Flooring: Carpeting and other flooring materials may qualify for a 5-year depreciation schedule.
Land improvements: Certain improvements to the land, such as landscaping or paving, can be depreciated over a 15-year period.

By identifying these components and depreciating them over their respective shorter time frames, you can front-load your depreciation deductions. This means you can claim larger deductions in the early years of ownership, reducing your taxable rental income and potentially increasing your cash flow during this crucial period.

It's important to note that accelerated depreciation does not change the total amount of depreciation you can claim over the life of the property. Instead, it allows you to claim a larger portion of that depreciation upfront, providing a tax benefit when you may need it most.

Accelerated Depreciation Methods for Real Estate

In addition to the cost segregation strategy discussed earlier, there are two other accelerated depreciation methods that you can use for your single family rental properties in 2024: 100% bonus depreciation and Section 179 expensing.

100% Bonus Depreciation

Increased bonus depreciation: The Tax Cuts and Jobs Act increased bonus depreciation to 100% for qualifying assets placed in service from September 27, 2017, through December 31, 2022. This means you can deduct the full cost of certain property improvements in the year they're placed in service, rather than depreciating them over a longer period.
Phase-down begins in 2023: Starting in 2023, the 100% bonus depreciation begins to phase down by 20% each year. In 2024, the bonus depreciation rate will be 80%. This means that if you place a qualifying asset in service in 2024, you can deduct 80% of its cost in that year, with the remaining 20% depreciated over the standard depreciation period for that asset type.
Qualifying assets: To be eligible for bonus depreciation, the asset must have a recovery period of 20 years or less under the Modified Accelerated Cost Recovery System (MACRS). This includes assets such as appliances, flooring, and certain land improvements.

Section 179 Expensing

Immediate expensing: Section 179 allows you to immediately expense the cost of certain qualifying property in the year it's placed in service, instead of depreciating it over multiple years. This can provide a significant upfront tax deduction, reducing your taxable rental income in the year of purchase.
Limitations: There are some limitations to Section 179 expensing. For 2024, the maximum deduction is $1,160,000, and this begins to phase out once the total amount of qualifying property placed in service exceeds $2,890,000. Additionally, the deduction is limited to your taxable income from all sources, not just rental income.
Qualifying property: Section 179 can be applied to tangible personal property, such as appliances and furniture, as well as certain improvements to nonresidential real property, like roofs, HVAC systems, and fire and security systems. It's important to note that not all assets eligible for bonus depreciation qualify for Section 179 expensing, so it's crucial to consult with a tax professional to determine the best strategy for your specific situation.

Is Accelerated Depreciation on Single Family Rentals Worth It?

Accelerated depreciation can be a valuable strategy for real estate investors looking to maximize their tax benefits and increase cash flow in the early years of rental property ownership. By front-loading depreciation deductions, you can potentially reduce your taxable rental income and keep more money in your pocket when you may need it most.

Consider your investment timeline: If you plan to hold the rental property for the long term, accelerated depreciation may be less advantageous, as you'll have lower depreciation deductions in later years. However, if you anticipate selling the property within a few years, accelerating depreciation can provide significant tax benefits upfront.
Weigh the cost of a cost segregation study: To take advantage of accelerated depreciation, you'll likely need to conduct a cost segregation study. This can be expensive, especially for smaller rental properties. Assess whether the potential tax savings justify the upfront cost of the study.
Plan for depreciation recapture: When you sell a rental property that has been depreciated, you may face depreciation recapture taxes on the accumulated depreciation claimed over the years. This can result in a significant tax liability upon sale. However, you can defer these taxes by executing a 1031 exchange and reinvesting the proceeds into a like-kind investment property.
Evaluate your overall investment strategy: Accelerated depreciation can be a powerful tool, but it's not right for every investor. Consider your overall investment goals, risk tolerance, and cash flow needs when deciding whether to pursue this strategy. If your primary focus is on long-term appreciation and steady cash flow, the benefits of accelerated depreciation may be less compelling.

Ultimately, the decision to use accelerated depreciation for your single family rental properties in 2024 depends on your unique circumstances and investment objectives. Consult with a experienced real estate tax professional to determine if this strategy aligns with your goals and to ensure compliance with all relevant tax laws and regulations.

Accelerated depreciation can be a game-changer for real estate investors looking to maximize their tax benefits and boost cash flow in the early years of rental property ownership. If you're ready to take advantage of this powerful strategy for your single family rental investments in 2024, Doorvest can help you get started. Our team of experienced real estate professionals will guide you through the process, from identifying the right properties to conducting cost segregation studies and ensuring compliance with all relevant tax laws. Take the first step towards building long-term wealth and achieving financial security with Doorvest today.