First-Year Depreciation

Definition

First-Year Depreciation, also known as Bonus Depreciation or Additional First-Year Depreciation, is an immediate expense deduction that allows property owners to gain a larger depreciation deduction in the first year than what is normally allowed under standard depreciation schedules. This special allowance provides a significant incentive for real estate investors to boost their cash flow by reducing taxable income and thus tax liabilities early on in the property’s life.

Examples

Commercial Real Estate Purchase: If you purchase a commercial building for $1 million in a qualifying year, you might be able to take a substantial portion (e.g., $100,000) as a first-year depreciation expense rather than depreciating that portion over typical 39 years.
Residential Rental Property: Suppose you purchase a residential rental property for $500,000. With first-year depreciation rules, qualifying improvements or expenses might allow you to take an immediate $50,000 deduction off your taxable income.

Frequently Asked Questions (FAQs)

What qualifies for First-Year Depreciation?

Eligible property typically includes tangible personal property such as machinery, equipment, and certain improvements made to residential or commercial buildings.

Is First-Year Depreciation mandatory?

No, taxpayers can elect out of bonus depreciation for any class of property for a particular tax year.

Does Bonus Depreciation apply to used property?

Yes, as of the Tax Cuts and Jobs Act of 2017, both new and most used qualified property can be eligible for bonus depreciation.

Is Bonus Depreciation available for all tax years?

Eligibility for bonus depreciation can change based on tax law updates. For instance, temporary provisions may enhance or restrict the benefit in certain years.

How does First-Year Depreciation differ from Section 179 deductions?

While both are methods for immediate expensing, Section 179 is limited to the amount of income from a business and has an annual dollar cap, whereas bonus depreciation does not have income limitations and affects taxable income directly.

Depreciation: The systematic allocation of the cost of an asset over its useful life.
Section 179 Deduction: A tax deduction that allows businesses to deduct the full purchase price of qualifying assets financed or leased during the tax year.
Modified Accelerated Cost Recovery System (MACRS): The current method of depreciation for tax purposes in the United States, which allows for accelerated depreciation.
Qualified Improvement Property (QIP): Any improvement to the interior portion of a commercial building, provided the improvement is placed in service after the building was first placed in service.

Online Resources

References

IRS. (2020). Publication 946: How to Depreciate Property. Internal Revenue Service.
Tax Cuts and Jobs Act. (2017). H.R.1—115th Congress (2017-2018).

Suggested Books for Further Studies

“Real Estate Taxation: A Practitioner’s Guide” by David F. Windish.
“Tax-Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes” by Tom Wheelwright.
“Accelerating Depreciation: Property, Plant, and Equipment” by Salvatore Sedita.

Real Estate Basics: First-Year Depreciation Fundamentals Quiz

### What primary benefit does First-Year Depreciation offer real estate investors? - [x] A larger depreciation deduction in the first year - [ ] Lower interest rates on mortgages - [ ] Immediate increases in property value - [ ] Qualification for government subsidies > **Explanation:** First-Year Depreciation allows for a larger deduction in the first year, thereby reducing taxable income for that year. ### Can First-Year Depreciation apply to both new and used property? - [x] Yes, both new and most used qualified property are eligible. - [ ] No, only newly purchased property. - [ ] Only used property. - [ ] It depends on the property's geographic location. > **Explanation:** Following the Tax Cuts and Jobs Act of 2017, both new and most used qualified properties can qualify for bonus depreciation. ### What is another name for First-Year Depreciation? - [ ] Accelerated Depreciation - [x] Bonus Depreciation - [ ] Straight-Line Depreciation - [ ] Section 1231 Expense > **Explanation:** First-Year Depreciation is also commonly known as Bonus Depreciation. ### Under which act was First-Year Depreciation expanded to include used property? - [ ] Dodd-Frank Act - [ ] Sarbanes-Oxley Act - [x] Tax Cuts and Jobs Act - [ ] Affordable Care Act > **Explanation:** The Tax Cuts and Jobs Act of 2017 expanded bonus depreciation to include used property. ### Is First-Year Depreciation the same as the Section 179 deduction? - [ ] Yes - [x] No - [ ] Only in certain states - [ ] IRS treats them as interchangeable > **Explanation:** While similar, First-Year Depreciation and Section 179 deductions are different with distinct rules and limitations. ### Can taxpayers opt out of using First-Year Depreciation? - [x] Yes, they can elect out of bonus depreciation for any class of property. - [ ] No, it's mandatory for all qualifying properties. - [ ] Only if specific IRS approvals are obtained. - [ ] Only if the property is commercial. > **Explanation:** Taxpayers can elect out of the bonus depreciation for any class of property for a particular tax year. ### Which depreciation method adjusts annually allowances for asset classes? - [ ] Straight-Line Depreciation - [x] Modified Accelerated Cost Recovery System (MACRS) - [ ] Double-Declining Balance Method - [ ] Sum-of-the-Years-Digits Method > **Explanation:** The Modified Accelerated Cost Recovery System (MACRS) is the principal method for accelerated depreciation in the U.S. ### Depreciation allows for deductions even if the property is used for personal purposes. - [ ] True - [x] False - [ ] Only under certain circumstances - [ ] Only with IRS clearance > **Explanation:** Depreciation deductions are allowable for income-producing properties, not for personal-use properties. ### What is the primary difference between Section 179 Deduction and First-Year Depreciation? - [ ] Section 179 increases property value; First-Year Depreciation does not. - [x] Section 179 has a cap and is limited to business income, whereas First-Year Depreciation does not. - [ ] First-Year Depreciation is available only for residential properties. - [ ] Both require asset usage reviews. > **Explanation:** Section 179 has an annual dollar cap and is limited to the amount of income from a business, whereas First-Year Depreciation allows for a more significant deduction without these limitations. ### In which IRS publication can information about depreciation, including First-Year Depreciation, be found? - [ ] Publication 938 - [x] Publication 946 - [ ] Publication 555 - [ ] Publication 583 > **Explanation:** IRS Publication 946 provides detailed information on how to depreciate property, including rules for First-Year Depreciation.