How to Use Bonus Depreciation in a REIT or DST
The tax landscape for real estate investments has dramatically shifted over recent years, creating unprecedented opportunities for sophisticated investors. Among these game-changing provisions, bonus depreciation stands as a powerful wealth acceleration tool that many operators overlook or underutilize.
But here's the reality: while traditional depreciation slowly chips away at your tax burden over decades, bonus depreciation transforms your tax strategy overnight. For real estate sponsors and investors managing $100M+ portfolios, understanding and leveraging this provision isn't just advantageous—it's essential for building the kind of permanent capital structures that create generational wealth.
This comprehensive guide reveals how bonus depreciation works within REITs and Delaware Statutory Trusts (DSTs), and why mastering these strategies positions you to retain control while maximizing investor returns.
What Is Bonus Depreciation?
Bonus depreciation allows property owners to immediately deduct a significant percentage of certain property improvements and equipment costs in the year they're placed in service, rather than spreading these deductions over multiple years through traditional depreciation schedules.
Under current tax law, qualifying property receives 100% bonus depreciation through 2022, with the benefit phasing down by 20% annually starting in 2023. This means 2023 allows 80% bonus depreciation, 2024 allows 60%, and so forth, until the provision expires in 2027—unless Congress acts to extend it.
The provision applies to tangible personal property with a recovery period of 20 years or less, qualified improvement property, and certain other specified assets. In real estate contexts, this typically includes fixtures, equipment, carpeting, signage, and specialized building components that can be separated from the underlying structure.
The Mechanics: How Bonus Depreciation Accelerates Wealth Creation
Traditional real estate depreciation follows a predictable but slow path. Residential rental property depreciates over 27.5 years, while commercial property spreads deductions across 39 years. This methodical approach provides steady tax benefits but fails to capitalize on immediate opportunities.
Bonus depreciation revolutionizes this timeline by front-loading deductions for qualifying components. Instead of deducting $10,000 annually for equipment with a 10-year life, you claim the entire $100,000 deduction in year one.
The transformation becomes even more powerful when you consider the time value of money and investment compounding. A dollar of tax savings today generates significantly more wealth than the same dollar saved five or ten years from now.
Consider a commercial property acquisition with $2 million in qualifying improvements and equipment. Under traditional depreciation, these components might generate $150,000 in annual deductions. With bonus depreciation, that same $2 million creates an immediate deduction, potentially saving $400,000 to $600,000 in taxes during the acquisition year, depending on the investor's tax bracket.
Cost Segregation: The Foundation of Bonus Depreciation Strategy
Cost segregation studies serve as the engineering foundation that unlocks bonus depreciation's full potential. These detailed analyses separate real property components into categories based on their depreciable lives and bonus depreciation eligibility.
A qualified cost segregation study examines every aspect of a property—from flooring and lighting systems to specialized HVAC components and tenant improvements. The study identifies which elements qualify as personal property or land improvements with shorter depreciable lives, making them eligible for accelerated depreciation methods including bonus depreciation.
The process requires collaboration between engineers, tax professionals, and construction specialists who understand both the technical aspects of building systems and the nuances of tax law. This investment typically pays for itself many times over through the additional deductions it uncovers.
For properties worth $1 million or more, cost segregation studies routinely identify 20% to 40% of the property's basis as qualifying for accelerated depreciation. On a $10 million acquisition, this translates to $2 million to $4 million in additional first-year deductions when combined with bonus depreciation.
Bonus Depreciation in Delaware Statutory Trusts (DSTs)
DSTs have emerged as sophisticated vehicles for 1031 exchanges, offering institutional-grade properties with professional management while preserving like-kind exchange benefits. When combined with bonus depreciation, DSTs create powerful tax-deferral mechanisms that extend far beyond traditional exchange strategies.
The structure of DSTs makes them particularly well-suited for bonus depreciation benefits. Since DST investors hold beneficial interests in the trust that owns the underlying real estate, they receive their proportionate share of all tax benefits, including accelerated depreciation deductions.
This becomes especially valuable for investors transitioning from active real estate management to more passive investment approaches. A real estate developer who has built substantial wealth through hands-on development can exchange into DSTs, maintaining tax deferral while accessing bonus depreciation benefits that offset other passive income sources.
The timing advantages prove particularly compelling. An investor completing a 1031 exchange into a DST near year-end can potentially claim significant bonus depreciation deductions for that tax year, even though they held the investment for only a few months. This acceleration can offset gains from other sources and provide immediate cash flow benefits.
DSTs also enable investors to diversify across multiple properties and markets while maintaining the ability to claim bonus depreciation benefits from each underlying asset. This diversification reduces risk while multiplying the potential tax benefits available through accelerated depreciation strategies.
REITs and Bonus Depreciation: Maximizing Shareholder Value
Real Estate Investment Trusts utilize bonus depreciation as a powerful tool for minimizing taxable income at the entity level, allowing them to pass through greater tax-deferred distributions to shareholders. This mechanism transforms REITs into more efficient wealth-building platforms while maintaining their required distribution characteristics.
REITs must distribute at least 90% of their taxable income annually to maintain their tax-advantaged status. However, bonus depreciation reduces that taxable income figure, creating a beneficial disconnect between cash flow and taxable distributions. The REIT generates strong operating cash flows while reporting lower taxable income due to accelerated depreciation deductions.
This creates what sophisticated investors recognize as "tax-deferred dividends"—distributions that exceed the REIT's taxable income and are therefore treated as return of capital rather than taxable income to shareholders. These distributions reduce the shareholder's cost basis in the REIT shares rather than creating immediate tax liability.
For investors building generational wealth platforms, this tax deferral compounds over time. The money that would have gone to taxes remains invested and continues generating returns. When the shares are eventually sold, the gains may qualify for favorable capital gains treatment rather than ordinary income tax rates.
Modern REITs increasingly focus on acquiring properties with significant bonus depreciation potential, recognizing that these acquisitions create immediate value for shareholders through enhanced after-tax returns. This strategy particularly benefits REITs focused on newer properties or those undertaking substantial renovations and improvements.
The Strategic Advantage: Building Permanent Capital Structures
Bonus depreciation creates opportunities that extend far beyond simple tax savings. For operators building permanent capital platforms, these provisions enable strategies that transform business models from episodic transactions to self-reinforcing wealth engines.
Consider how bonus depreciation enhances UPREIT structures. When properties are contributed to an operating partnership in exchange for units, the depreciation benefits flow through to unit holders while the REIT maintains operational control. Contributors defer taxes on their property sales while accessing institutional-grade liquidity and professional management.
The bonus depreciation benefits make these structures even more attractive to potential contributors. A developer completing a project can contribute it to an UPREIT, defer gain recognition, receive operating partnership units that trade like public securities, and immediately benefit from substantial depreciation deductions that offset other income sources.
This creates a flywheel effect: the enhanced tax benefits attract more property contributions, which increases the platform's scale and management capabilities, which in turn attracts even more contributors seeking the same benefits. The result is a self-reinforcing ecosystem that grows stronger with each transaction.
Implementation Strategies for Maximum Impact
Successfully leveraging bonus depreciation requires careful planning and professional execution. The most effective strategies begin with property acquisition analysis, incorporating potential depreciation benefits into investment underwriting from the outset.
Smart operators conduct preliminary cost segregation analyses during due diligence, estimating bonus depreciation benefits before finalizing acquisitions. This enables more accurate investment projections and may justify higher acquisition prices when the tax benefits are properly valued.
Timing becomes crucial for maximizing benefits. Properties placed in service late in the tax year still qualify for full-year bonus depreciation deductions, creating opportunities for strategic closing schedules. However, investors must also consider the phase-out schedule and plan for reduced benefits in future years.
Documentation proves essential for defending these deductions. Proper cost segregation studies, detailed invoicing, and clear allocation methodologies protect investors in the event of IRS scrutiny. The substantial deductions generated by bonus depreciation may increase audit risk, making thorough documentation a critical component of any strategy.
Legislative Outlook and Future Considerations
The current bonus depreciation regime operates under a sunset provision, with benefits phasing out between 2023 and 2027. However, the provision has enjoyed bipartisan support due to its economic stimulus effects, and many tax professionals expect some form of extension or modification in future legislation.
Regardless of legislative outcomes, the principles underlying bonus depreciation—accelerating tax benefits to enhance investment returns—remain sound wealth-building strategies. Even if bonus depreciation percentages decrease or expire entirely, cost segregation studies and accelerated depreciation methods continue providing valuable benefits for real estate investors.
Forward-thinking operators are already adjusting their strategies to account for the phase-out schedule. This might involve accelerating acquisition timelines, increasing focus on properties with substantial qualifying improvements, or restructuring investment vehicles to maximize current-year benefits.
The potential for legislative extension also creates planning opportunities. Investors might defer certain improvements or acquisitions if they believe more favorable bonus depreciation terms could be reinstated. However, this speculation must be balanced against the certainty of current benefits and the risks of policy changes.
Transform Your Capital Strategy Today
Bonus depreciation represents more than a tax planning technique—it's a fundamental tool for building the kind of permanent capital structures that create lasting wealth. Whether you're operating through REITs, DSTs, or direct ownership structures, these provisions offer immediate opportunities to accelerate your wealth-building timeline.
The most successful real estate operators recognize that tax strategy isn't separate from investment strategy—it's an integral component that can dramatically enhance returns and create competitive advantages. In an environment where access to capital increasingly determines success, bonus depreciation provides a powerful tool for generating the cash flow necessary to fund growth and expansion.
Don't let the complexity of these provisions prevent you from capturing their benefits. The cost of proper planning and implementation pales in comparison to the wealth acceleration these strategies enable. Partner with qualified professionals who understand both the technical requirements and the broader strategic implications of bonus depreciation planning.
Your investors expect sophisticated tax strategies that maximize their after-tax returns. Your growth plans require the enhanced cash flows that come from optimized tax planning. The time to act is now, while current provisions remain at their most generous levels.
The question isn't whether you can afford to implement these strategies—it's whether you can afford not to. In a competitive marketplace where marginal advantages compound into substantial wealth differences, bonus depreciation offers the kind of transformative opportunity that separates industry leaders from the rest of the field.
Transform your approach to real estate taxation. Build the permanent capital structures that create generational wealth. The tools are available, the benefits are proven, and the time for action is now.
