• Internal Revenue Code §168 governs depreciation methods applicable to tangible property, including bonus depreciation.
• Bonus depreciation allows eligible property to be depreciated more rapidly than standard depreciation schedules.
• Accelerated depreciation increases near-term deductions but can increase future tax exposure under §1250.
• §168 plays a central role in cost segregation studies and long-term real estate tax planning strategies.
What It Is
Section §168 establishes the Modified Accelerated Cost Recovery System (MACRS), which governs how tangible property is depreciated for federal tax purposes. Bonus depreciation, authorized under §168(k), allows taxpayers to immediately deduct a significant portion of the cost of qualifying property in the year it is placed in service, rather than depreciating it over its normal recovery period.
In commercial real estate, bonus depreciation is most commonly accessed through cost segregation studies that reclassify portions of a building into shorter-lived property categories eligible for accelerated depreciation.
Historical Context
Accelerated depreciation has long been used by Congress as an economic stimulus tool. Bonus depreciation was significantly expanded under the Tax Cuts and Jobs Act of 2017, which temporarily allowed 100% expensing of qualifying property.
Subsequent legislation introduced phase-down schedules, gradually reducing the percentage of bonus depreciation available each year. Despite these reductions, bonus depreciation has remained a recurring policy focus, with lawmakers periodically extending or modifying the provision to encourage continued investment in capital-intensive assets such as commercial real estate.
Commercial Real Estate Context
Commercial real estate investors frequently use cost segregation and bonus depreciation to front-load depreciation deductions, materially improving near-term cash flow and after-tax returns. Although bonus depreciation percentages have been scheduled to phase down, recent legislation once again extended bonus depreciation availability, reinforcing its continued relevance in current acquisition and planning decisions.
While these accelerated deductions provide meaningful benefits early in the investment lifecycle, they also increase future §1250 exposure upon sale unless deferred through a §1031 exchange or resolved through long-term planning strategies.
Potential Benefits & Limitations
Potential Benefits
• Enhanced Early Cash Flow – Accelerated depreciation can materially increase after-tax cash flow in early years.
• Tax Rate Arbitrage – Allows deductions to be taken during higher-income years.
• Strategic Integration – Works effectively alongside §1031, §721, and long-term estate planning strategies.
Potential Limitations
• Increased Future Recapture – Accelerated depreciation increases exposure to §1250 recapture upon disposition.
• Temporary Policy Risk – Bonus depreciation availability is subject to legislative changes.
• Complex Implementation – Requires cost segregation studies and careful tax coordination.
Application
In practice, §168 bonus depreciation functions as a powerful front-end tax planning tool rather than a permanent tax solution. Sophisticated investors evaluate bonus depreciation in conjunction with exit strategies, ensuring that accelerated deductions align with long-term plans involving §1031 exchanges, §721 contributions, or eventual basis step-up under §1014. When properly coordinated, bonus depreciation enhances overall portfolio efficiency without creating unintended future tax consequences.