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Beware of Bonus Depreciation in NY State for Real Estate Investors

Jun 1, 2021

Real estate investors often get excited about bonus depreciation. They envision massive deductions that will offset their income and enable them to pay little or no income tax. While this may be true for federal purposes, it is not true for New York State tax purposes. NY State tax can actually increase as additional bonus depreciation is claimed. Overlooking NY State bonus depreciation adjustments could be particularly costly due to recent NY State income tax hikes. The top combined NY State/NY City tax rate for a NY resident living in NY City could be as high as 14.776%. The top NY State tax rate for a NY State non-resident could be as high as 10.9% on NY source income. As such, it is crucial that real estate investors and operators understand their personal tax situations and don’t automatically assume that bonus deprecation will make income tax liability disappear. 

There are two fact patterns where bonus depreciation can increase NY State tax liability. One of these pertains to NY State residents and the other to NY State non-residents. 

Bonus Depreciation Trap for NY State Residents

NY State residents are generally taxed on their federal income subject to certain adjustments. One of these adjustments is for bonus depreciation. The bonus depreciation adjustment for NY State is an addback to federal adjusted gross income. This addback occurs even if the federal bonus depreciation deduction is limited on the federal return. This means that not only do you not get to deduct the loss in the current year, you also have to pay tax on the bonus depreciation in NY State even though no federal benefit was derived from the deduction. In some situations, the more bonus depreciation claimed at the federal level, the higher the NY State tax will be. Here is an example: 

Item Federal NY State
Rental Income 20,000,000  20,000,000
Rental Expenses [1] (30,000,000) (30,000,000)
Bonus Depreciation [2] (50,000,000) (50,000,000)
Income Before Loss Limitation (60,000,000) (60,000,000)
Loss Limitation [3] 59,476,000 59,476,000
Adjusted Gross income - Pre-Bonus Depreciation Adjustment (524,000) (524,000)
Bonus Depreciation Adjustment                - 40,000,000
Adjusted Gross Income - Post-Bonus Depreciation Adjustment (524,000)   39,476,000

[1] - Excludes bonus depreciation.

[2] - Assumes a $50MM five-year MACRS asset. Without bonus depreciation, the depreciation deduction would have been $10MM.

[3] - Business losses are limited to $524,000 for the 2021 tax year under provisions of the Internal Revenue Code dealing with “excess business losses of noncorporate taxpayers.” Any additional loss is claimed as an NOL in the subsequent tax year. 

If the bonus depreciation deducted in the federal column increases, the loss limitation addback also increases by the same amount, which means that adjusted gross income before bonus depreciation adjustments would still be ($524,000). Even though the federal income doesn’t change by the increased bonus depreciation deduction, you are required to add it back for NY State purposes as if it had been deducted. This would increase NY State adjusted gross income and NY State income tax.   

Bonus Depreciation Trap for NY State Non-Residents

NY State non-residents are typically only taxed on their NY source income. However, NY State requires non-residents to recalculate their passive activity deduction to determine the amount that is allowed if the federal adjusted gross income took into account only items of income, gain, loss or deduction derived from NY sources. 

Assume a non-resident of NY had passive income from Florida sources of $1 million and a passive loss from NY State sources of $1 million all generated by bonus depreciation[1]. For federal purposes, this taxpayer would have no income. But, for NY State purposes, the $1 million loss would be disallowed and an $800,000 NY State addback related to bonus depreciation would be required. This means that this taxpayer would pay NY State income tax on $800,000 of income when the only NY source activity had a $1 million loss. In this example, if the taxpayer elected out of bonus deprecation, no NY State income tax would be owed.

It is imperative that real estate investors and operators take these facts into consideration before deciding to claim bonus depreciation. Real estate investors, operators and their accountants should model the federal and NY State tax liability for their investors to ensure that they are not inadvertently increasing their investors’ tax by claiming bonus depreciation.

[1] Assumes a 5 year MACRS asset.  Without bonus depreciation, the depreciation deduction would have been $200K. 

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