By Rena Morris, Registered Representative, Emerson Equity | Irvine Advisors, LLC

Smart investing is no longer just about striving to generate income – but preserving it. Post COVID, investing success requires a focus on assets that target durable, necessity-based income backed by strong operators in historically resilient industries.

This article focuses on tax-efficient investing strategies for real estate investors, providing another strategy to leverage tax advantages like bonus depreciation to defer net rents and capital gains tax liability generated from the passive activity of real estate investment.

Real property, including improvements like buildings and infrastructure, is subject to depreciation, which reduces taxable income. This allows real estate investors to offset their income and lower their tax burden. Many commercial rental properties are broadly classified as having a useful life of 39 years, while Retail Motor Fuel Outlets, for example, are classified as having a 15-year depreciation period.

The One Big Beautiful Bill Act has officially reinstated 100% bonus depreciation for qualified property, restoring one of the most significant tax advantages for real estate investors. Originally introduced under the 2017 Tax Cuts and Jobs Act, bonus depreciation allows investors to fully depreciate the eligible portion (purchase price, excluding land) of qualified property in the year of acquisition.

Most real property will not qualify for bonus depreciation because the scheduled depreciation is greater than 20 years. A relatively small percentage of real estate has been granted a depreciation schedule shorter than 20 years and is therefore able, according to the tax code, to utilize bonus depreciation. Retail Motor Fuel Outlets (gas stations) are one such property class that qualifies for bonus depreciation and does not need further engineering studies or analysis, as provided for in Internal Revenue Code (IRC) Section 168(e)(3)(E)(iii).

A sophisticated investor can acquire gas station properties and use leverage to amplify depreciation benefits. With 100% bonus depreciation reinstated for 2025, investors can fully depreciate the eligible portion of the purchase price (excluding land) in the year of acquisition, significantly maximizing their tax deductions and overall tax efficiency. If investing in this asset class through a syndicated portfolio fund, this sophisticated investor can mitigate some of the risks caused by economic, geographic and operator concentration.

Since the depreciation is sometimes greater than the cash flow a property will reasonably be expected to generate over a typical investment horizon of 5-10 years, the investor could ideally be able to use these dramatic depreciation expenses to offset income from other sources. The question then becomes, what income can investors offset?

Real Estate Investment Income or loss from rental real estate is, for most investors, a passive activity. Investors with portfolios of rental real estate, particularly real estate that has been owned and depreciated for a long time are likely to have significant passive income that is currently being taxed as ordinary income. Investors should be encouraged to review Form 8582, which reports the Passive Activity Income or Loss from their tax return. If Line 3 is positive, the investor has passive income that should be investigated further.

Use of Bonus Depreciation

Here are some ways real estate investors benefit from the use of bonus depreciation:

• Failed 1031 Exchange. An investor who is unable to complete an orderly 1031 exchange would, in many cases, have passive income that is either section 1231 (capital gains) or section 1250 (recapture) – both of which can often be offset by depreciation expenses. An investor with a failed 1031 exchange or a partial exchange that resulted in boot should consult with their tax preparer to determine how the gains from sale will be characterized and if the bonus depreciation strategy is applicable.
• Inactive Business Interest. Some investors may own businesses in which they are no longer active and the income derived from those businesses may be considered passive income. As indicated above, this determination must be made with careful consideration and consultation with competent tax representation.
• Real Estate Professionals. Some investors may be real estate professionals, as defined in the Internal Revenue Code. In which case, it may be possible for them to either invest as active participants in real estate, which would otherwise be considered passive activity, or aggregate all their real estate activities to claim active status. This can be particularly powerful for some investors but requires careful consideration and consultation with competent tax representation.

Final Thoughts

Sophisticated investors understand that positive returns are just the beginning of an effective investment strategy. Tax efficiency is key to attempting to protect gains, maximize returns, and build generational wealth. Investing in necessity based asset classes that offer the potential for stable income and risk-adjusted returns provides a strong foundation for any portfolio. Strategic use of debt can further enhance investment capacity. Finally, allocating capital to leveraged, necessity-based real assets that qualify for bonus depreciation, such as retail motor fuel properties, can significantly enhance a portfolio’s tax efficiency.

References: IRC Sec. 168(e)(3)(E)(iii) provides that a retail motor fuels outlet is 15-year property even though food or other convenience items are sold at the outlet. Depreciable real property qualifies as a retail motor fuels outlet if (1) 50% or more of the gross revenue from the property is from petroleum sales or (2) 50% or more of the property’s floor is devoted to petroleum marketing sales. A facility that is no more than 1,400 square feet in size is exempted from the 50% tests. Under IRC Sec. 168(g)(3)(B) , the recovery period is 20 years under the alternative depreciation system of IRC Sec. 168(g) . Rev. Rul. 97-29 held that a retail motor fuels outlet qualifies as 15-year property whether or not the taxpayer-owner is also the operator.

This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for tax, legal, or accounting advice. Investors should consult with competent, independent, tax representatives before engaging in any transaction. Every investor should have their own, independent, competent tax representation. Rena Morris has been a Registered Representative since 2004 with Emerson Equity | Irvine Advisors, LLC. For more information, contact Ms. Morris at rmorris@irvineadvisorsllc.com or (626) 354-4372.

Securities through Emerson Equity LLC, member FINRA (www.finra.org) and SIPC (www.sipc.org). All investing involves risk of loss of some or all principal invested. Speak to your tax and/or financial professional prior to investing. Emerson is not affiliated with any other entity herein.

Real Estate Risk Disclosure

• There is no guarantee that any strategy will be successful or achieve investment objectives including, among other things, profits, distributions, tax benefits, exit strategy, etc.
• Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments.
• Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
• Potential for foreclosure – All financed real estate investments have potential for foreclosure.
• Illiquidity – These assets are commonly offered through private placement offerings and are illiquid securities. The secondary market for these investments is very limited, and early sale is not guaranteed.
• Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions.
• Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.
• Stated tax benefits – Any stated tax benefits are not guaranteed and are subject to changes in the tax code. Speak to your tax professional prior to investing.