You might already be an investment property owner or you are mulling over the idea of becoming one. With that in mind, all properties depreciate, but it is how the depreciation expense can help you maximize your tax savings that is the key factor. It might seem daunting and uninteresting, but it is an area that you, the investor, will need to tackle and familiarize yourself with.
The important fact behind depreciation is that everything has a shelf-life whether it is your car, produce that you keep in your refrigerator, electronic equipment in your home, and the list goes on. With that said, there is also taxation that will affect your property.
An investor has to realize that taxation for individuals is different than for a business. As an individual, your gross income is taxed and the rest is yours to spend it in whatever way you choose. On the flip side, businesses are able to deduct their expenses and are taxed on what remains. This is a great advantage for you, for the reason that the ability to depreciate costs before taxes is highly profitable.
Here is an sample case scenario on how this would work – picture that you have just purchased duplex for $100,000 which pulls off $10K of cash flow per year. So it would be your cost of $100,000 minus the net income of $10,000 which leaves you with a total taxable income of $90,000. This reflects how there is a negative $90,000 – a loss. However, the silver lining here is that you would not only pay any taxes on this yearʼs income, but that you would have 10 years before owing any taxes – what a gift! Unfortunately, the IRS cannot stand to be kept waiting for this long, so they have a figured out a system where this amount is split up over several years and it is usually based on the life-span of the item
Residential real estate tends to depreciated over a 27.5 years and this timeframe was determined by the IRS. The initial depreciable expense is divided evenly over 27.5 year and for each year thereafter 1/27.5th is applied.
If you have a CPA, please consult with them for your particular real estate needs. Depreciation discussions is not everyoneʼs cup of tea, but I hope I have given you a glimpse into this important concept. Feel free to send in your comments and questions that are specific to your need and I will do my best to answer them.