The Tax Break Nobody Explained to Me: What 100% Bonus Depreciation Means for Passive Investors

By: Jason Ottilo | Co-Founder | Next Legacy Group

The first time I got a K-1 from a real estate deal, I thought something had gone wrong.

The property was performing. I'd received distributions all year. And yet the form said I had a loss. I called the sponsor half-convinced I was about to hear bad news.

What I heard instead was a ten-minute explanation that changed how I think about real estate forever. I'm going to give you that same explanation here, because it's the most misunderstood advantage of passive investing, and because as of last year the rules got meaningfully better.

The government lets you pretend the building is wearing out.

When you buy a rental property, the IRS treats the building (not the land) as an asset that slowly loses value. For residential real estate, that "wearing out" is spread over 27.5 years, and each year you deduct a slice of the building's cost against the income it produces. That's depreciation.

Here's what matters: it's a paper deduction. No cash leaves your pocket. The building may actually be going up in value while the IRS lets you write it down.

Take a $10 million apartment community: $8 million of building, $2 million of land. Straight-line depreciation is roughly $290,000 a year. Meaningful, but slow.

Now speed it up: cost segregation and bonus depreciation.

A building isn't one thing. It's carpet, appliances, cabinets, parking lots, landscaping, and hundreds of other components. The tax code says many of those wear out in 5, 7, or 15 years, not 27.5.

A cost segregation study is an engineering report that identifies those pieces and moves them into their shorter recovery periods. On a typical garden-style apartment property, 20% to 35% of the purchase price lands in those faster buckets.

Bonus depreciation is the accelerator on top. It lets the owner deduct those short-life components in the first year instead of spreading them out.

And here's the news: the tax legislation signed in July 2025 restored bonus depreciation to 100% and made it permanent for property acquired after January 19, 2025. Under prior law it had been phasing down (60% in 2024, 40% in 2025, headed to zero). That phase-down is gone.

Back to our $10 million property. If a cost segregation study moves 25% of the $8 million building into short-life assets, that's $2 million deductible in year one, plus roughly $220,000 of regular depreciation on the rest. Call it $2.2 million of deductions against a property that might earn $500,000 after expenses and debt service. On paper, the property just "lost" about $1.7 million while making half a million dollars.

What that means for you: the $100,000 investor

When you invest in a fund or syndication, you own a slice of the entity that owns the property. Every dollar of depreciation is divided among the owners in proportion to their ownership and lands on your K-1.

Say the deal raised $4 million of equity and you invested $100,000. You own 2.5%. Your share of that $1.7 million paper loss is roughly $42,000. Meanwhile, at a 7% preferred return, you received about $7,000 in cash.

So your K-1 shows a $42,000 loss. Your bank account shows $7,000 in deposits. That's exactly what happened to me, and it's the moment most new investors call their sponsor in a panic.

Plainly, you can receive cash distributions and owe little or no current federal income tax on them.

The honest caveat: "passive" is a tax term.

A lot of online content oversells this, so let me be straight with you.

First, a definition. "Passive" here isn't a description of your effort. It's an IRS category. Income and losses from a deal you don't materially operate are passive income and passive losses, and the tax code keeps them in their own bucket.

The rule: passive losses can offset passive income, but they generally cannot offset your W-2 salary or business income. Your $7,000 distribution is passive income, so this deal's loss shelters it completely. The remaining $35,000 of loss doesn't touch your paycheck.

The main exception is real estate professional status: roughly, more than half your working hours and at least 750 hours a year in real estate activities you materially participate in. That's a high bar, not a box you check casually.

For everyone else, here's the good news: passive losses don't disappear. They're suspended and carried forward. That $35,000 sits on your return, waiting.

Now watch what happens when you invest in a second deal two years later. Deal one has mostly used up its accelerated depreciation and starts showing taxable income, maybe $8,000 a year on your K-1. Deal two just generated a fresh $40,000 loss.

The new loss shelters the old income, and the suspended losses keep stacking. When either property is fully sold, any remaining suspended losses are released against the gain. Investors who build a portfolio of a few deals often go years paying little current tax on their real estate income. That's the compounding tax engine nobody teaches.

What happens when the property sells?

Depreciation is a deferral, not a gift. At sale, the depreciation you took is "recaptured": the building portion is taxed at up to 25%, and the short-life components can be taxed at ordinary rates. The rest of your gain is taxed at long-term capital gains rates, which are lower than what you pay on salary.

Even so, three things work in your favor. You had use of that money for years instead of sending it to the IRS up front. Your suspended losses come back to offset the gain.

And a sponsor with a plan can roll proceeds into the next acquisition through a 1031 exchange, which I wrote about a few weeks ago, and keep the deferral going.

Deferred tax is a zero-interest loan from the government that you get to invest.

How we think about it at Next Legacy Group.

We don't buy properties for the tax benefits. We buy properties that make sense on the fundamentals: real demand, debt we can service comfortably, and operators we'd trust with our own money (and we do). The tax treatment is the bonus, not the thesis.

But we do think about your after-tax experience. We commission cost segregation studies where they make sense. We structure acquisitions to qualify for bonus depreciation. And we'll show you, before you invest, what year one is likely to look like on your K-1.

If you want to see a real one from a Next Legacy deal, reach out through the Next Legacy Fund page. We'd rather show you than tell you.

I'm not your tax advisor, and every situation is different. Talk to a CPA who understands real estate before acting on any of this.

But walk into that conversation knowing the right questions: What does year-one depreciation look like on this deal? Is there a cost seg study? What can I do with a passive loss? What happens at the sale?

Ask those, and you're already thinking like the investors I wish I'd been around at 25.