Depreciation Advantage for Hold Properties

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Tony Robinson, one of our local investors, wrote the following article on the value of depreciating your properties.  Depreciation gives you HUGE tax advantages which is a large income stream that not everyone considers when they’re contemplating becoming a landlord.

I hope the following explains some of the advantages you may not have considered.  If you have any questions about depreciating properties, please add them here to the comments section so we can clear up any confusions.

Here’s a synopsis of Tony’s article:

Many of us using the long term hold strategy fail to capitalize on one of the true benefits of owning real estate. Though the benefits are many, I find the ability to offset income by maximizing depreciation to be the most valuable of all. Did you know that depreciation allowances offset the gross income received on real estate?

Let me explain. The IRS extends the benefit of depreciation to owners of rental property.  Here, the government is actually giving us an incentive to own real estate! The depreciation factor for single family residential property is 27.5 years. This means that you can take depreciation on the “dwelling” spread out over 27.5 years.

An example of how depreciation works is as follows:

You buy a house for $100,000.00; the dwelling value is $80,000.00 and the land is $20,000.00. You cannot depreciate the land, however you factor depreciation on the dwelling by dividing the dwelling value by 27.5 (80,000 ÷ 27.5 = $2,909.09). In this example, that gives you a depreciation allowance of $2,909.00 per year.

If you don’t know how sweet this is let me explain. This means that if you rented the property for $800.00 per month and your mortgage was say, $600.00 per month, you would have a positive monthly cash flow of $200.00 or $2,400.00 per year of income. Now factor in that the IRS allows the depreciation deduction, and your income is now offset by the depreciation expense (2400.00 – 2,909.00 = -509.00).

This means that, for tax purposes, you lost $509.00 on this property. Now– you and I know that this is a “paper loss” only, as you actually made $2,400.00. The sweet part is that although you are depreciating the property on paper you are, if you purchased correctly, receiving the added benefit of  “appreciation” as the value of the property is increasing over time. How sweet is that?

And, you can maximize the depreciation for your long term holds by doing what’s called “componentized” depreciation. This allows you to break out certain components of the property and depreciate them separately, i.e. the carpet may be componentized and broken out as personal property which can be depreciated over 5 years. This would also apply to appliances, HVAC, roof, etc.  You might want to get with your accountant/CPA to see how to implement this into your long term hold business structure.

One other point in the example illustrated above–the depreciation put you at a loss (on paper) before you even started to deduct your normal business expenses such as maintenance, cleaning, travel, supplies, interest, taxes—my gosh!!!! It goes on and on!

Go Buy a House!!!

Any questions?

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7 Comments

  1. It’s absolutely the same here in the US.

    That’s another reason we, like you, prefer to hold properties rather than sell. Also, because we have so many properties, we have a lot of write-offs and still don’t pay tax, even when we sell and “recapture” the depreciation we have claimed.

    If, for example, you have $250,000 in write-offs, you can earn that much, break even and not pay tax on up to $250,000 in profits.

    We also off-set the recapture by selling with owner financing. That way, our recapture is spread out over the time we finance to our buyer.

    Thanks for pointing out this important aspect of depreciating properties for tax purposes.

  2. We have similar depreciation laws in Australia (on new properties only) but there is a sting in the tail, when you go to sell, all that derpeciation you’ve used reduces the “purchase price” you paid so your capital gains go up by the same amount you’ve saved throughout. Which is fine with me since I don’t plan on selling (the rental income is what I live off of) and since capital gains tax is typcially less than the tax paid on rental income, but if you plan on selling, I think it is worth understanding how depreciation affects any tax you’ll pay later.

    How does it work in the US?

  3. That’s SOOOO funny!

    I had a CPA the year I qualified – only my CPA knew nothing of the rules. That CPA almost cost me $4000 in taxes!!!

    I no longer work with that CPA…

  4. Well, congratulations on your stellar year, but let’s see if we can make EVERY year stellar! Instead of reading the law for yourself, check with a CPA who works with real estate investors. I would love to see you have that added tax benefits!

  5. As I read the law in order to qualify as a real estate professional, I have to have 750 hours plus more than 50% of my hours worked in real estate.

    I hold a full-time job and though I manage my properties myself, the way I’ve set up my business means I have to spend very little time on them.

    That first year was stellar though!!!

  6. Clint:

    Are you certain you don’t qualify for real estate professional tax benefits? Its so easy to get the hours (750 per year), especially if you own 16 units! It doesn’t have to be your full time job or main source of income, you know.

    Thank you for sharing your big revelation. There are so many amazing ways real estate pays benefits!

  7. I remember when the power of depreciation struck me. I Had just made an acquisition of 16 units – which were in desperate need of attention and tenants. All the work that year pushed me into the “real estate professional” category for tax reasons.

    What a windfall!!! My taxable income fell all the way to $1080 (total tax liability that year was $108!).

    While subsequent years weren’t as extreme (it was the only year I qualified as a real estate professional), the depreciation I do receive wipes out huge amounts of income ($25,000)!

    The depreciation of rental income is a HUGE benefit to REI – I only wish I had know about it earlier.

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