Why the Biggest Deduction Isn’t Always Best With 100% Bonus Depreciation

When 100% bonus depreciation is on the table, the instinct is to take as much of it as possible in year one. It feels like the obvious win. But the biggest deduction isn’t always the best one, and taking it at the wrong time can cost you more than it saves.

During a recent episode of Your CPA’s Take on Real Estate, Kyle Paxton shared valuable insights on how real estate investors should approach bonus depreciation and cost segregation. The discussion highlighted the importance of planning depreciation around the full economics of a deal instead of chasing the largest possible write-off.

A Big Deduction Only Helps If You Can Use It

Accelerated depreciation creates a loss on paper. Whether that loss reduces your taxes is a separate question.

Real estate investors have to work through a series of limitations before a loss can be used. You need basis in the investment, and that basis has to be at risk. The loss has to be treated the right way for you as a taxpayer. In many cases you also need to qualify as a real estate professional and materially participate. Kyle counts “seven different hoops you have to jump through” before the deduction actually works for you.

If you can’t clear those hurdles this year, a large deduction this year does very little.

Tax Brackets Decide What a Deduction Is Worth

Even when you can use the loss, timing still matters because the U.S. has a progressive tax system. The same deduction is worth more when it offsets income taxed at a higher rate.

Here’s a simple way to see it. $100,000 of depreciation that offsets income taxed at 10% saves $10,000. The same $100,000 against income taxed at 37% saves $37,000.

That’s why Kyle doesn’t default to year one. Given the choice between offsetting 10% tax this year or 37% next year, he said, “I’m going to choose 37% next year almost every time.”

Why Deducting Now Isn’t Always the Smart Play

There’s a fair argument for taking deductions early. Money saved today can be reinvested today, so all else being equal, a deduction now is generally better than the same deduction later.

The catch is that all else is rarely equal. A few factors can change the answer.

Your Other Income

Look at what else is on your personal return this year and what you expect over the next year or two. A deduction used in a low-income year may be worth far less than one saved for a high-income year.

Your Hold Period

If you plan to sell soon, a big deduction now can set up a big gain later. As Kyle put it, “it may not make sense to go ahead and take a large deduction this year just to have a large gain next year.”

State Tax Rules

Not every state treats depreciation the way the federal rules do. Those gaps are easy to miss and can lead to surprises, so state treatment belongs in the plan from the start.

Plan It During Underwriting, Not at Tax Time

Depreciation affects the after-tax economics of an investment, which means it belongs in the conversation before you buy. That doesn’t mean the cost segregation study has to be finished before closing. It’s usually done afterward and can even be completed years later, with a Section 481(a) catch-up adjustment to correct prior depreciation.

What matters is that the strategy is considered while the deal is still being underwritten. It’s also worth revisiting before year end. Kyle sees a common pattern with real estate investors: several years of little or no tax, followed by a large and unexpected bill. Looking ahead gives you time to plan for those years instead of reacting to them.

Rethinking the Year-One Deduction

100% bonus depreciation is a valuable tool, but the real question isn’t how much you can deduct. It’s when that deduction will do the most good. If you’re buying a property this year and haven’t mapped out your income for the next few years, start there.

Watch the full episode with Kyle Paxton to hear the questions he recommends asking before closing and how to decide whether cost segregation makes sense for your property.

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