Depreciation for real estate investors.
Depreciation of assets is not specific to real estate since it relates to nearly every kind of business, but there are some special things about real estate depreciation that investors should understand and benefit from.
There is a lot of talk in the world of real estate and taxes when it comes to depreciation. In the most simple of terms, you’re getting paid by the government for your income generating property getting worn down over time.
Any “improvement” to the land, such as a building, will start to deteriorate over time. Depreciation is the government’s way of letting you pay that cost over multiple years. When you consider my video on depreciation recapture here then this is more like tax deferment not avoidance.
More like DEFERMENT of taxes not avoidance.
For more on that, again check out our class on recapture. Okay so depreciation, in terms of real estate investing, is being able to take tax deductions that are spread over 27.5 years (usually) to offset the cost of buying and making improvements to properties, like building a house.
When you’re holding onto a property longer than one year, here is a list of some basic criteria the proeprty should meet…
As long as…
It is NOT vacant land.
You’re the legal owner.
You don’t sell it in the same year.
It is going to last more than one year, etc.
It is used for an income producing purpose NOT to live in.
It has determinable useful life (gets worn down, loses value over time, decays, etc.)
Then it’s probably going to be able to be depreciated.
If you buy and sell an income property in the same year, it won’t be eligible for depreciation tax deductions. When your investment property is ready to be used THEN it becomes eligible for depreciation. So if you have to fix it up the benefits won’t kick in until all the work is completed and it is move-in ready.
Depreciation last from when the property is ready to be used by an end user (a renter for example) all the way until you have deducted the entire cost of the property, you sell it, make it for personal use, it is destroyed, etc.
Depreciation basically lasts until the property stops being useful.
Useful meaning the ability to generate income, if that happens, it stops depreciating. Or at least that is the idea and purpose of these laws, in the case that there is no more money being made the government tends to think that all the loss of value has been realized, the asset has depreciated to rock bottom.
Here’s the basic equation.
Take the cost of the land and the cost/value of the building on the land and separate them. The easiest way to do this is to use most recent tax assessment to obtain the property value. Subtract this number from the fair market value of the property, and now you have the simplest land/building cost separation.
So if a property is worth $300,000 all you need to know is the value of either the land or the house built on the land, if you know one you can calculate the other. So if the land is worth $100,000 and the property is worth $300,000 then you know the value of the house on the land (the “improvement”) is about $200,000.
Now it is simply a matter of taking the building value and dividing it by 27.5 and that is multiplied by your your marginal tax rate.
This will also depend on which method you are using.
This is where it really depends on what method you’re using and how the depreciation time line plays out. If you’re using the General Depreciation System then it’s going to span over 27.5 years.
The other method is Alternative Depreciation System and that spans 40 years (for a property put not use after 12/31/17) ADS methods are really used more in properties that will be used like farm land, tax exempt holdings, business use 50% of the time or less, etc.
Here’s an example.
If you configure your total purchase, let’s say on a $200K property where $80K is land and you’re tax rate is 22% it will look like this;
200K- 80K= 120K
So the land of the house itself without the land is $120,000.
Now we divide that by 27.5 = $4363.63
That is what we can write off every year, but then we multiply that by our tax rate which in this example is 22%, so $4363.63 x .22 (22%) = $960 in depreciation.
Some helpful places:
CPApowered.org – You need to speak with an expert, even if you are one, here’s a website where you can find a CPA near you.
HomeUnion.com – This is an article that explains more about depreciation on rental properties, I don’t know anything about them or Moe Ansari, so if you do please give me some feedback. This article is good.
IRS info on deductions – This is a BUNCH of legal mumbo jumbo, but in case you are a Nerdy Birdy like me I included it because most people will hate but I love learning about this stuff.
Check out our comic below.
Annisa = )
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