MHP Bonus Depreciation
Mobile home park depreciation probably deserves several posts. It’s a major reason why investors flock to the asset class, so it’s best to understand the details and not just blindly trust your CPA.
For today, let’s cover the basics then narrow in on Cost Segregation + Bonus Depreciation.
Sum of the Parts
For obvious reasons you can’t depreciate land - dirt is hard to damage. But what about the pipes, fencing, roads and sidewalks? These are all physical items that will eventually degrade and need to be replaced.
To account for this, the IRS lets us offset the value of this assumed deterioration from our income each year.
The default schedule for depreciating the value of residential real estate is 27.5 years.
These individual components have their own depreciation schedules. Often their useful lives are far shorter than 27.5 years.
However, on your tax return you can choose a “change of accounting election” and itemize the individual component valuations of your property (plumbing, carpet, land improvements, etc.).
For example, personal property is 5 year property, therefore with straight-line depreciation, you can take a paper “loss” of 20% of all personal property on your tax return each year for 5 years.
Most land improvements such as asphalt & landscaping have a useful life of 15 years while interior fixtures can typically be depreciated over 7 years.
This is huge - remember MHPs tend to kick off a lot of cash. Offsetting a park’s income with depreciation artificially reduces your taxable income.
Cost Segregation
In order to speed up the default 27.5 year schedule and take advantage of the faster schedules, you need to pony up for a Cost Segregation analysis.
This is a 3rd party valuation of the individual components of your property.
Instead of depreciating a property as a whole - the resulting report will itemize and categorize the different parts of the property that can be depreciated.
Example Deal
Lets say you bought a $10 million dollar mobile home park and after your analysis determine the following:
Land value: $3 million
Improvements + other value: $7 million
Because - once again - you can’t depreciate the land value you just depreciate the $7M over 27.5 years at $254,545 each year.
That would likely shelter all of the cash flow in year one.
But wait, you remember that MHP Weekly post said there’s this thing called Cost Segregation & after paying for this magical report you determine of the remaining $7 million, $5M is sub 27.5 year property.
$4,000,000 in land improvements depreciated over 15 years
$500,000 in ‘fixtures’ depreciated over 7 years
$500,000 in personal property depreciated over 5 years
$2,000,000 in other residential property depreciated over 27.5 years
(for ex: pipes connected to homes)
This means that Year 1 depreciation would increase from $254,545 to $510,823 -just like that.
At that level, you’re starting to offset passive income not just from this property but from other assets as well (or perhaps ordinary income, if you’re a real estate professional).
Not too shabby.
Bonus Time
But why stop there?
As most experienced park investors / operators know, you can supercharge after-tax returns by using bonus depreciation to accelerate 15 year or less property to year one.
In 2023 you can take 80% of the total depreciation on 15 year property or less the year you buy the property. That percentage will degrade by 20 percentage points per year until bonus depreciation disappears in 2027.
Side note - I highly doubt we’ll see bonus depreciation like this again anytime soon so use or lose it.
Back to math.
So taking that same $5M of sub 15 year property, accelerated to year 1, you now have a paper loss of $4M in 2023 (80% of $5M).
Unreal.
With a 70% LTV loan, that means your first year “losses” would have exceeded your TOTAL equity investment in the deal.
The tax code LOVES real estate investors.
Now…this isn’t free money. You’ll have to pay depreciation recapture once you go to sell the park. But that tends to be a lower rate (25%) than the ordinary income rates you would have paid on income in year one. And, you would have benefited from the time value of deferring those taxes.
Plus there are other ways to bypass recapture taxes when the time comes:
1031 Exchange
Never sell - buy, refi, die
Gift to kids at a stepped up basis (value)
Hopefully this is obvious, but MHP Weekly is not your accountant. If so, we are grossly underpaid.
To be clear, we would never pass a CPA test because we’d die halfway through from sheer boredom.
Therefore, be sure to chat with your CPA before jumping head first into advanced tax strategies.
Happy Trails,
MHP WEEKLY