The Tax Break Nobody Explained to Me: What 100% Bonus Depreciation Means for Passive Investors
By: Jason Ottilo | Co-Founder | Next Legacy Group
A real estate investment can generate cash distributions while showing a tax loss on your K-1.
That may sound confusing.
How can you receive cash from an investment while the tax documents show a loss?
One important part of the answer is depreciation.
For passive real estate investors, understanding depreciation, cost segregation and bonus depreciation can help explain how a property can produce cash flow while also generating significant tax deductions.
The Basics: What Is Depreciation?
Depreciation is essentially a paper deduction.
The IRS allows investors to deduct the cost of certain real estate assets over time. The deduction represents the gradual use or deterioration of the property for tax purposes.
The important point is this:
Depreciation does not require cash to leave your bank account.
A property can potentially increase in value while depreciation creates a tax deduction.
For residential rental property, the building portion is generally depreciated over 27.5 years, subject to applicable tax rules.
That creates an annual deduction even though you are not writing a check for that amount each year.
Why Cost Segregation Matters
A multifamily property is more than its walls and roof.
Inside and around a property are many components that may have shorter depreciation lives.
A cost segregation study identifies and separates certain components of a property so they can potentially be depreciated over shorter periods.
These may include:
Appliances
Carpeting
Cabinets
Landscaping
Parking improvements
Certain building systems
Other shorter-life assets
Instead of waiting years to receive the full benefit of depreciation, cost segregation can accelerate deductions into the earlier years of ownership.
This is where bonus depreciation becomes particularly important.
What Is 100% Bonus Depreciation?
Bonus depreciation allows qualifying assets to be deducted much faster than under traditional depreciation schedules.
Under legislation enacted in 2025, 100% bonus depreciation was restored and made permanent for qualifying property acquired after January 19, 2025, subject to applicable requirements.
For investors, this can potentially create a much larger first-year depreciation deduction.
Consider a simplified example.
A $10 Million Multifamily Property
Imagine a multifamily property purchased for $10 million.
For illustration:
$8 million = building
$2 million = land
A cost segregation study identifies approximately $2 million of potentially shorter-life assets
Additional regular depreciation may apply to the remaining building basis
The exact results depend on the property, acquisition structure, cost segregation study and applicable tax rules.
But the concept is important:
A significant first-year paper loss could potentially be generated even while the property produces cash flow.
What Could This Mean for a $100,000 Investor?
Let's make the example more personal.
Suppose you invest $100,000 in a multifamily investment with a total equity raise of $4 million.
Your approximate ownership would be:
$100,000 ÷ $4,000,000 = 2.5%
Now suppose your share of the deal's depreciation-related loss was approximately $42,000.
Your K-1 could potentially show:
-$42,000 tax loss
At the same time, suppose you receive:
+$7,000 in cash distributions
That does not necessarily mean you lost $42,000.
The $42,000 represents a tax loss generated by depreciation, not necessarily a cash loss.
This illustrates one of the important distinctions in real estate investing:
Taxable income and cash flow are not always the same thing.
The Important Catch: Passive Loss Rules
There is an important limitation investors need to understand.
Passive losses generally remain subject to passive activity rules.
In many situations, passive losses cannot simply be used to offset W-2 wages or active business income.
Instead:
Unused passive losses may be suspended.
Suspended losses may generally carry forward.
When a qualifying investment is sold, suspended losses may become available to offset income or gain, subject to applicable rules.
Tax treatment depends on the investor's individual circumstances and investment structure.
Real estate professional status can change how certain passive losses are treated.
However, qualifying as a real estate professional involves specific requirements and should not be assumed.
This is why investors should always discuss their individual situation with a CPA or qualified tax advisor.
What Happens When You Sell?
Depreciation can provide valuable deductions during the ownership period, but investors also need to understand what can happen when an investment is sold.
Certain depreciation deductions may be subject to recapture rules.
In simple terms, some of the tax benefits received during ownership can affect the tax treatment of a future sale.
A 1031 exchange may also provide another strategy for investors seeking to defer certain taxable gains when the requirements are met.
The details matter.
Your tax advisor can help determine how depreciation, recapture, suspended passive losses and a potential 1031 exchange could apply to your individual situation.
At Next Legacy Group, Fundamentals Come First
At Next Legacy Group, we don't buy multifamily properties simply because they offer potential tax benefits.
Fundamentals come first. Taxes come second.
We focus on:
Real demand
Sustainable debt
Strong property fundamentals
Experienced operators
Long-term investor value
When appropriate, we also consider cost segregation and bonus depreciation as part of the overall investment strategy.
Tax benefits should support a strong investment thesis.
They should not be the reason to make an investment.
As investors, we believe the better question is not simply
"What tax benefit can I get?"
It is:
"Does this investment make sense before the tax benefits?"
That distinction matters.
The Bigger Picture for Passive Investors
For passive multifamily investors, depreciation can be one of the most valuable tools to understand.
A properly structured investment may potentially provide:
Cash distributions + depreciation deductions + long-term real estate exposure
But every investment is different.
The amount of depreciation you receive depends on factors such as:
Purchase price
Property basis
Cost segregation results
Ownership percentage
Investment structure
Applicable tax law
Your individual tax situation
There is no one-size-fits-all answer.
The goal is to understand the numbers before you invest.
Final Thought
We don't buy properties for the tax benefits. We buy properties that make sense, and we think about your after-tax experience.
Want to understand what this could look like in a real Next Legacy investment?
Explore the Next Legacy Fund and learn more about our approach to multifamily investing.
Join us tonight and keep learning before making your next investment decision!
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