Bonus Depreciation in Commercial Real Estate: Rules, Timing, and Tax Benefits

A practical guide to using bonus depreciation to reduce tax liability, improve cash flow, and plan property improvements with timing strategies in mind.
Aerial view of multifamily rowhouses in the Central Northside neighborhood of Pittsburgh, Pennsylvania.

What is Bonus Depreciation?

Bonus depreciation is a tax incentive that lets businesses immediately deduct a large percentage of qualifying asset costs in the year the asset is placed in service.

 

Bonus depreciation accelerates how businesses recover the cost of certain purchases, like equipment, software, or property improvements. Instead of spreading deductions over several years, this provision allows for a significant first year write off freeing up cash and reducing taxable income.

It's available for qualified assets with a recovery period of 20 years or less under the Modified Accelerated Cost Recovery System (MACRS). This includes many items used in commercial real estate, such as building components, land improvements, and certain equipment purchases.

For example, if you upgrade the interior of a nonresidential building with qualified improvement property upgrades, that may be eligible for bonus depreciation if placed in service after 2017. Investors can also pair this strategy with tools like a 1031 exchange to defer gains and manage tax exposure long term.

How Bonus Depreciation Works

Bonus depreciation lets businesses deduct a large portion of an asset's cost in the same year the asset is placed in service. It applies automatically unless you opt out, and it's available for new and used property acquired after 2017.

The deduction equals the cost of the asset multiplied by the bonus rate for that year. For example, if you purchase and place in service business software in 2025 for $80,000, and the bonus depreciation rate that year is 40%, you can deduct $32,000 immediately. The remaining $48,000 is depreciated using MACRS over the asset's standard recovery period.

Claiming it requires IRS Form 4562. If you choose not to take bonus depreciation, you must file an election to opt out by the return's due date. Once claimed, bonus depreciation affects your basis and may trigger depreciation recapture if you sell the asset.

This accelerated deduction improves cash flow by reducing taxable income in the first year. It's especially useful for investors making leasehold improvements or using tenant improvement allowance funds on leased office space.

Office Space for Rent

 

TCJA Impact and Bonus Depreciation Phase Out

The Tax Cuts and Jobs Act (TCJA) made two major changes: it extended bonus depreciation to used property and increased the deduction to 100% for qualified assets placed in service after September 27, 2017. This gave investors a way to fully write off eligible purchases in the first year.

But the 100% deduction was temporary. Starting in 2023, bonus depreciation began phasing out by 20% each year. By 2027, it will be gone entirely. That makes the next few years critical for anyone planning large capital investments.

Line graph showing the bonus depreciation phase-out schedule from 2022 to 2027, declining from 100% to 0%.
Bonus depreciation decreases from 100% in 2022 to 0% by 2027, making early asset placement critical for tax savings.
  • 2022: 100%
  • 2023: 80%
  • 2024: 60%
  • 2025: 40%
  • 2026: 20%
  • 2027 and beyond: 0%

If you're upgrading property or buying depreciable assets, timing matters. The placed in service date controls which percentage you can claim. Acting early could mean thousands in extra deductions.

Some investors pair bonus depreciation with longer-term tax strategies. For example, they may time acquisitions inside an opportunity zone or apply it as part of a broader strategy when buying commercial property. This approach can combine immediate deductions with future capital gains deferral.

Eligibility Rules and Qualifying Property

Bonus depreciation applies to tangible assets with a recovery period of 20 years or less under MACRS. The property itself doesn't qualify, but assets like HVAC units, lighting, appliances, and land improvements often do.

Used property may also qualify if it wasn't previously used by the taxpayer, wasn't acquired from a related party, and meets IRS acquisition rules. This expands eligibility to reused materials or secondhand equipment in renovation projects.

Cost segregation is especially valuable for multifamily and land investors. It breaks down a property into shorter life components, like site lighting, parking lots, or utility systems, many of which qualify for bonus depreciation if placed in service during a qualifying year.

Land For Sale

 

Long Term Tax Planning

Bonus depreciation can lower your tax bill in the year of purchase, but it often leads to depreciation recapture when you sell. Recapture is taxed as ordinary income, up to 25%, which means a large write off today could become a sizable tax hit later if you're not prepared.

This makes timing critical. If you sell in a high income year, the recapture could push your tax bracket even higher. But if you exit in a low income year, or spread payments out with an installment sale, the tax impact can be reduced. Some investors also use a sale leaseback strategy to unlock capital without triggering recapture right away.

The key is to plan ahead. If your asset is generating a strong rate of return or favorable internal rate of return, the early tax savings might justify the future cost. But if you expect to sell soon, or don't have offsetting losses, it may be worth evaluating whether to take bonus depreciation at all.

When to Elect Out of Bonus Depreciation

You don't have to take bonus depreciation. If you expect higher income in future years, it may be better to spread deductions out. To elect out, file IRS Form 4562 and apply the change to all property in the same class.

This strategy works well for stable assets with long hold periods. Use tools like cash on cash return or discounted cash flow models to see if deferring deductions improves your overall return.

Multi-State Compliance and Conformity Strategies

Not all states follow federal bonus depreciation rules. Some conform fully, others have decoupled, and a few apply partial conformity. This creates challenges for investors operating in multiple states.

Before you claim a deduction, check each state's rules. In states that don't conform, you may need to add back the bonus amount on your state return. This can reduce your actual tax savings and raise your occupancy costs, especially for investors operating across multiple jurisdictions.

Frequently Asked Questions

How will the phase out of bonus depreciation affect my tax planning strategy over the next few years?

The bonus depreciation percentage drops each year. To maximize tax savings, consider accelerating purchases so assets are placed in service before the next phase down. If that's not possible, evaluate whether Section 179 can help fill the gap as bonus depreciation winds down.

What's the difference between bonus depreciation and Section 179 deductions, and when should I use each one?

Section 179 lets you choose which assets to deduct, but it's capped at $1,250,000 in 2025 and limited to your taxable business income. Bonus depreciation applies automatically to all qualifying assets and has no dollar limit. Use Section 179 when you want control and you're under the cap. Use bonus depreciation when you're making large purchases, want to create a loss, or have already maxed out Section 179.

What are the potential tax implications when I sell property that received bonus depreciation?

You may owe depreciation recapture tax. That portion of the gain is taxed as ordinary income, up to 25%, rather than at lower capital gains rates. If you're planning a sale, run projections to understand the tax hit. In some cases, it makes sense to defer or spread the gain using tools like installment sales or strategic timing during low-income years.