This blog was provided by Capstan Tax Strategies, a premier sponsor of the PICPA.

By Terri S. Johnson, CRE

The multifamily real estate market remains steady and robust. Along with the opportunity to earn rental income, multifamily projects offer a number of tax benefits to the thoughtful investor. In fact, we’re finding that investors view the tax savings associated with cost segregation as a major reason to consider the multifamily sector. Recent provisions in the CARES Act and 2017’s Tax Cuts and Jobs Act (TCJA) have brought depreciation deductions to an all-time high. The TCJA established a 100% bonus depreciation rate through the end of 2022. The impact of 100% bonus depreciation on tax savings cannot be overstated, but time is running out on this valuable incentive. As shown in Table 1, the bonus depreciation rate will step down by 20% a year beginning Jan. 1, 2023.

Table 1

Here is an example to illustrate the effect of this step-down. Property ABC, a garden apartment complex, was acquired and placed in service in September 2018 with a total depreciable basis of $37,445,200. Engineers were able to move 18.7% of assets into five-year personal property, and another 7% of assets into 15-year land improvements. When 100% bonus depreciation is in play, there would be a first-year tax savings of $3,142,872.

However, once bonus depreciation begins to step-down, the scope of savings decreases commensurately, as seen in Table 2.

Table 2

Now is the time for investors to move forward with new construction and acquisitions if they want to be assured of the 100% bonus depreciation.

When used in tandem with other tax strategies, 100% bonus depreciation is even more valuable:

• The Tangible Property Regulations (TPRs) guide the taxpayer in making expense and capitalization decisions. Materiality and BAR (Betterment, Adaptation, and Restoration) Testing help ensure that all possible assets are expensed.
• Partial Asset Dispositions are useful in renovation scenarios. If a multifamily property was purchased and renovated, the remaining depreciable basis of the discarded assets may be immediately written off in the current year. Data generated by a cost segregation report can be used to produce and support disposition tables.
  Let’s return to Project ABC. In December 2019, the property underwent a renovation with an associated depreciable basis of $3 million. The same engineer returned to the property to document the discarded assets. He was also able to move 32% of the new assets into five-year. Between both strategies, first-year tax savings on the renovation was $325,000.
• Energy-efficient tax incentives are also in play. The EPAct 179D deduction has been permanently extended and is an option for multifamily facilities that are four or more stories high. The deduction is per square foot – up to $1.80 per square foot – so the bigger the better. The 45L tax credit can be used for apartment buildings, condos, and townhouses on projects that have been designed for high energy-efficiency. The credit is $2,000 per unit, so the savings can really multiply. Keep in mind, however, that the 45L tax credit has only been extended through Dec. 31,2021.  

These strategies – with the possible exception of 45L – will be around even after the bonus depreciation step-down begins. But to maximize real estate tax savings, the time is now. Do you have a new construction planned? Want to acquire a new-to-you property? Considering a renovation? Planning your project timing around tax benefits can have a major impact and this should be considered when meeting with your CPA.

A quality cost segregation study is the key to maximizing tax savings on multifamily properties, or really any type of commercial real estate. The study allows you to leverage a combination of strategies old and new, increasing cash flow, reducing tax liability, and teeing you up for better days ahead.

Terri S. Johnson, CRE, is a partner at Capstan Tax Strategies. She can be reached at tjohnson@capstantax.com.

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