Depreciation recapture remains a looming hazard
1031 Exchanges Face Unprecedented Pressures From Bonus Depreciation Trends
The restoration of full 100% bonus depreciation in 2025 has supercharged the value proposition of 1031 exchanges, fundamentally reshaping the landscape for institutional investors seeking tax deferral and accelerated returns.
Far from a technical tweak, this policy shift allows real estate buyers to pair like-kind exchanges with immediate, sizable write-offs on new acquisitions—a double-edged tax advantage that changes how deals are timed, underwritten and exited.
This current regime has breathed new life into the 1031 exchange strategy, making deferral of capital gains even more lucrative when acquisition dates and cost segregation studies are aligned for maximum depreciation.
Investors can now use a 1031 exchange to defer taxes on a sale, purchase a replacement asset and immediately take substantial bonus depreciation on qualifying components, freeing up capital for reinvestment or to bolster cash flow.
According to a Trepp podcast, the speedy benefits at the entry point are driving fresh momentum in institutional deal activity and supporting more aggressive underwriting assumptions for first-year returns.
However, Trepp experts warn that this amplified benefit also amplifies the risks at disposition, especially under market distress. Depreciation recapture remains a looming hazard: while deferral lets investors sidestep taxes upfront, any exit event—whether a voluntary sale outside a 1031 or a default—can trigger massive tax liabilities as accelerated depreciation is clawed back by the IRS.
As Lonnie Hendry notes, “It’s a valid tool… but if you’re one of those transactional investment firms… there’s a whole lot of tax consequence here that I think the general public just doesn’t pay attention to”. The sophisticated strategies touted by tax “gurus” can collapse under changing market conditions, where compressed timelines or distressed sales expose harsh realities that go beyond Instagram infographics.
With the latest legislative change, it is critical for institutional buyers and their advisors to model potential scenarios for all exit paths, not just the ideal tax-deferred ones. The interplay between bonus depreciation, cost segregation and 1031 like-kind exchanges now sits at the heart of commercial real estate strategy, making timing, execution and compliance more vital than ever.
In this new era, 1031 exchanges may be more valuable—yet also more dangerous—for those who misjudge their long-term plans or underestimate the cost of recapture at exit.
Source: GlobeSt.
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