How to Use Bonus Depreciation in a REIT or DST
Bonus depreciation has become one of the most influential tax tools available to real estate investors. While many owners rely on traditional depreciation to gradually reduce taxable income over time, bonus depreciation reshapes the entire timeline—delivering immediate deductions that can dramatically accelerate wealth creation.
For REIT operators, DST sponsors, family offices, and investors managing large portfolios, understanding how this provision works is essential. Used correctly, bonus depreciation can strengthen cash flow, improve after-tax returns, and help build long-term capital structures that support generational wealth planning.
This guide explains how bonus depreciation functions, why cost segregation is vital, and how REITs and DSTs use these rules to enhance investor outcomes.
What Bonus Depreciation Actually Does
Bonus depreciation allows qualifying components of a property to be written off in the year they are placed in service, rather than over a 5-, 7-, 15-, or 27.5-/39-year schedule. Instead of spreading deductions across decades, investors can capture a large percentage at once.
Under current tax law, bonus depreciation is scheduled to phase down from 100 percent in 2022 by 20 percent each year until expiring in 2027—unless Congress intervenes.
Qualifying items typically include:
• fixtures and equipment
• carpeting, cabinetry, and specialty finishes
• certain HVAC or electrical components
• tenant improvements
• land improvements such as paving or landscaping
These are elements that can be separated from the structural shell of a building and depreciated more quickly.
Why Bonus Depreciation Creates Immediate Value
Standard real estate depreciation spreads deductions evenly across long periods. Bonus depreciation compresses them into a single year. This shift dramatically improves after-tax cash flow.
One example: an investor acquires a property that has $2 million in components eligible for bonus depreciation. Traditional depreciation might produce $150,000 per year in deductions. Bonus depreciation allows a full deduction immediately—potentially reducing taxes by $400,000 to $600,000 depending on bracket.
That early tax savings can then be reinvested, strengthening the compounding effect that drives long-term wealth.
Cost Segregation: The Key That Unlocks Bonus Depreciation
Most real estate cannot simply be written off in one year. A cost segregation study is what separates a building into distinct components with shorter useful lives.
A proper study evaluates:
• building systems
• finishes and specialty components
• site improvements
• tenant build-outs
The goal is to determine which elements qualify for accelerated depreciation or bonus depreciation. Studies are performed by engineers and tax specialists who understand both construction and IRS rules.
For properties of $1 million or more, cost segregation often identifies 20 to 40 percent of the purchase price as eligible for accelerated treatment. On a $10 million property, that means $2–4 million in immediate deductions paired with bonus depreciation.
How Bonus Depreciation Works Inside a DST
DSTs are popular 1031 replacement vehicles because they offer passive ownership of institutional-grade real estate. Bonus depreciation enhances those benefits.
DST investors receive their proportionate share of the trust’s depreciation. When bonus depreciation applies, it creates especially strong first-year tax advantages.
Key benefits for DST investors:
• bonus depreciation can offset passive income from other real estate
• a 1031 investor can exchange late in the year and still claim depreciation for that tax year
• diversification across multiple DSTs expands the number of properties generating deductions
For investors moving from active management to passive ownership, DSTs can serve as a bridge—preserving tax deferral while continuing to produce meaningful depreciation benefits.
How REITs Use Bonus Depreciation to Drive Shareholder Returns
Bonus depreciation plays a different but equally important role inside a REIT.
A REIT must distribute at least 90 percent of taxable income, but depreciation reduces taxable income without reducing cash flow. Bonus depreciation enhances this effect by producing more upfront deductions.
This often results in:
• tax-deferred distributions to shareholders
• return-of-capital treatment for part of the dividend
• lower taxable income at the REIT level
• more efficient portfolio growth
These tax-deferred dividends reduce an investor’s basis in their shares but allow cash flow to remain largely shielded. When the shares are eventually sold, gains may be taxed at long-term capital gains rates.
Many modern REITs deliberately acquire properties with high bonus depreciation potential or undertake improvements that qualify for accelerated deductions. This creates additional value for shareholders beyond basic rental income.
Bonus Depreciation and UPREIT Structures
In a 721 UPREIT exchange, property owners contribute real estate to an operating partnership in exchange for OP units. The depreciation benefits of the contributed property—including bonus depreciation—flow through to OP unit holders.
For developers or long-time owners, this can be especially compelling. They can:
• defer capital gains through a 721 exchange
• transition into diversified REIT ownership
• receive significant depreciation deductions that offset passive income
• convert illiquid, actively managed assets into passive, professionally managed ones
This combination forms the basis of many permanent capital strategies and can create a powerful pipeline of contributions into the REIT.
Implementing Bonus Depreciation Strategically
To maximize the benefits, investors and sponsors should consider the following:
Conduct cost segregation during due diligence
Understanding potential tax benefits early leads to more accurate underwriting and acquisition decisions.
Time acquisitions strategically
A late-year closing still qualifies for full bonus depreciation in that tax year.
Maintain thorough documentation
Large deductions attract IRS scrutiny; well-supported cost segregation studies are essential.
Plan around the legislative phase-down
Bonus depreciation begins shrinking each year. Investors may choose to:
• accelerate improvements
• advance acquisition timelines
• structure contributions to capture remaining benefits
Even if bonus depreciation phases out, accelerated depreciation from cost segregation remains a powerful tax strategy.
The Bigger Picture: Building Capital Through Tax Efficiency
Bonus depreciation is more than a year-one deduction; it reshapes the economics of real estate ownership. For operators attempting to scale platforms, REITs seeking tax-efficient distributions, or families planning long-term wealth strategies, bonus depreciation provides a tangible and immediate advantage.
In a competitive market, these tax efficiencies often determine whether a deal produces strong after-tax returns or falls short. Investors who integrate bonus depreciation into their broader planning gain a structural advantage that continues to compound over time.
Moving Forward
Every investor’s tax situation is unique, but the principles behind bonus depreciation are universal. Combined with DST structures, REIT platforms, or UPREIT strategies, these deductions can enhance cash flow, improve after-tax returns, and help build the kind of durable capital base that lasts across generations.
