The multifamily market remains very strong as an investment. Along with providing 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. Since 2018, one of the major drivers has been 100% bonus depreciation for both new and used assets having a shorter than 20-year MACRS class depreciation life. Prior to the TCJA, you could only take bonus on new construction and renovation assets. Getting bonus on acquisitions has had a huge impact on commercial real estate, especially the multi-family sector.
Developers and investors are considering how to best maximize bonus in light of upcoming changes. Bonus rates will begin to decline by 20% a year starting in 2023, and eventually sunset December 31, 2026. This still gives taxpayers plenty of time to take advantage of bonus over the next 5 years. This gradual decline is shown in Table (1).
What is key moving forward is project timing. It is crucial to keep bonus depreciation in mind when planning closings on acquisitions, scheduling renovation and construction projects, and keeping projects on track. If an opportunity to acquire a property arises at year end, keep bonus depreciation in mind and try to avoid crossing into the new tax year. If you can manage to close at year end, the bonus depreciation rate will be 20% higher. The same goes for new construction and renovations. When possible, try to get at least a temporary certificate of occupancy by year end. It may be helpful to clearly communicate the message to contractors early in the process — completing the project before year end is very important for financial reasons.
Consider an example to illustrate the effect of the strategy discussed above. Property ABC, a garden apartment complex, was acquired and placed-in-service in September of 2018 with a total depreciable basis of $37,445,200. Engineers were able to move 18.7% of assets into 5-year personal property, and another 7% of assets into 15-year land improvements. When 100% bonus is in play, this results in a first-year tax savings of $3,142,872.
Table (2) shows the impact on the same project with declining bonus of 20% a year through 2026. Cost segregation studies will still bring great benefit, even with lower bonus rates, but it’s important to be aware that the 100% bonus rate only runs through the end of 2022.
Many in the industry are hopeful that the bonus will continue to be extended by Congress as we have seen since 2001. In the meantime, think strategically about project timing, whether you are investing in acquisitions or have renovation and new construction projects on the board. 2022 is a great time to take advantage of 100% bonus.
Bonus depreciation is even more valuable when used in tandem with other tax strategies:
- The Tangible Property Regulations (TPRs) are still very much in play, augmenting the utility of newer legislation. The TPRs guide the taxpayer in making expense and capitalization decisions, and BAR and Materiality testing helps ensure that all possible assets are expensed.
- Partial Asset Dispositions are useful in a renovation scenario. 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 of 2019, the property underwent a renovation with an associated depreciable basis of $3M. The same engineer returned to the property to document the discarded assets. He was also able to move 32% of the new assets into 5-year. Between both strategies the first-year tax savings on the renovation was $325,000.
- Energy-efficient tax incentives are also in play for multifamily properties. The EPAct 179D Deduction was recently permanently extended, and is an option for multifamily facilities that are 4 or more stories high. The deduction is per square foot — up to $1.80/sf — so the bigger the better. The 45L Tax Credit is extremely popular, and condos, townhouses, and apartment buildings that are a maximum of three stories high are all solid candidates. The credit is $2,000 per unit, so the savings can really multiply. Keep in mind however, that the 45L Tax Credit has currently only been extended through 12/31/2021.
These strategies – with the exception of 45L – are permanent and not expected to expire.
A quality engineering-based cost segregation study is the key to maximizing tax savings on a multifamily property, or really any type of commercial real estate. The study will allow you to leverage a combination of strategies old and new, increasing cash flow, reducing tax liability, and teeing you up for better days ahead.
Tempus fugit, carpe diem!