State Tax Implications of Bonus Depreciation for Real Estate Investors

Real estate investors often get excited about bonus depreciation. As 100% bonus depreciation begins for the 2025 tax year, real estate is whetting its appetite for frontloaded tax losses. Investors envision massive deductions that will offset their income and enable them to pay little or no income tax. While this can be true for federal tax purposes, it is not always true for state tax purposes. In certain states, the state tax liability can actually increase when bonus depreciation is claimed. Overlooking state bonus depreciation adjustments could be particularly costly in some states.  

There are two items to consider when determining whether bonus depreciation should be taken: 

1. Who will benefit from bonus depreciation? 
2. Are there state depreciation adjustments to consider? 

Key Takeaways

• The One Big Beautiful Bill Act restores 100% bonus depreciation for qualifying property placed in service after January 19, 2025, creating major federal tax planning opportunities for real estate investors.
• Many states, including New York and California, do not conform to federal bonus depreciation rules and require taxpayers to add back the full deduction when calculating state taxable income.
• New York residents who claim bonus depreciation may owe state income tax at rates as high as 14.776% even when they receive no federal tax benefit from the deduction.
• New York nonresidents face a separate risk: the state requires them to recalculate passive activity losses using only New York-source income, which can produce taxable state income even when federal income is zero.
• Tax-exempt investors such as foundations, IRAs, and pension funds do not benefit from bonus depreciation and may face additional complexity when it is claimed.
• Real estate funds and operators should model both federal and state tax outcomes for their investors before electing bonus depreciation, and explore alternative front-loaded deduction strategies where appropriate.

Who Benefits from Bonus Depreciation?  

Rental real estate is a per se passive activity for tax purposes. When reporting the loss activity on a tax return, these passive losses can only offset other passive income until the activity is disposed of in a taxable event. Most real estate private equity fund investors are passive since they are not materially participating and are not deemed Real Estate Professionals for tax purposes. These investors often don’t have other passive income, and so their losses are suspended to future tax years until they either dispose of the investment or have other passive income. 

Tax-exempt investors (e.g., foundations, IRAs, pensions, and institutional investors) will not benefit from bonus depreciation. In fact, bonus depreciation deductions can create additional complexity for tax-exempt investors, which is beyond the purview of this article.    

Which States Require a Bonus Depreciation Addback?

Many states do not allow bonus depreciation. Instead, many states will require a net positive adjustment (addback) for the difference between bonus deprecation and depreciation as if bonus was not allowed. 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 may also have to pay tax on the bonus depreciation even though no federal benefit was derived from the deduction. 

Using New York (NY) as an example, there are two fact patterns where bonus depreciation can increase state tax liability. One of these pertains to NY residents and the other to NY non-residents.  

Bonus Depreciation Trap for Some State Residents 

Some state residents, including those in NY and California, are generally taxed on their federal income, subject to certain adjustments, including an addback for bonus depreciation. 

In NY, the top combined NY/NY City tax rate for a NY City resident could be as high as 14.776%. The top NY tax rate for a NY non-resident could be as high as 10.9% on NY-source income, so additions due to bonus depreciation can be very costly (and there wasn’t even a federal tax benefit). 

Here is an example:  

This illustrates how the attractive opportunity to use bonus depreciation as a means to “front load” losses for investors can inadvertently create the opposite effect—a large, unexpected tax bill. 

Note that if the bonus depreciation increases, the loss limitation addback also increases by the same amount, which means that adjusted gross income before bonus depreciation adjustments would still be ($578,000). Even though the federal income doesn’t change by the increased bonus depreciation deduction, you are required to add it back for NY purposes as if it had been deducted. This would increase the New York adjusted gross income and New York income tax.    

How Bonus Depreciation Affects New York Nonresidents

NY non-residents are typically taxed only on their NY-source income. However, NY 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 sources of $1 million, all generated by bonus depreciation^[5]. For federal purposes, this taxpayer would have no income. But, for NY purposes, the $1 million loss would be disallowed, and an $800,000 NY addback related to bonus depreciation would be required. This means that this taxpayer would pay NY 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 depreciation, no New York income tax would be owed. 

What to Do Before Claiming Bonus Depreciation

It is imperative that real estate funds and operators take these facts into consideration before deciding to claim bonus depreciation. Real estate funds, operators, and their accountants should model the federal and New York State tax liability for their investors to ensure that they are not inadvertently increasing their investors’ tax by claiming bonus depreciation while exploring other opportunities to frontload deductions in the early tax years.  

Ready to model the federal and state tax impact for your investors? Contact EisnerAmper's Real Estate Tax practice using the form below to review your bonus depreciation strategy.

[1] Excludes bonus depreciation. 

[2] Assumes a $1MM five-year MACRS asset. Assumes 100% bonus depreciation. Without bonus depreciation, the depreciation deduction would have been $200,000. 

[3] Business losses are limited to $578,000 for married filing jointly taxpayers for the 2023 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.  

[4] Assumes AGI is equal to Taxable Income for illustration purposes. Also assumes the highest rate. 

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