The tax benefits of owning real estate are many. Did you know that you can offset your rental income by claiming the depreciation of your rental property, and the mechanical systems and appliances it contains, as they age? This deduction is not taken all at once, but figured over time.
The IRS extends the benefit of depreciation to owners of rental property. Through this tax benefit, the government is actually giving an incentive to own real estate! The depreciation factor for a single family residential property is 27.5 years, meaning you can take depreciation on the dwelling (not the land) spread out over 27.5 years.
How Depreciation Works
You buy a house for $100,000. The dwelling value is $80,000 and the land is $20,000. You cannot depreciate the land. Calculate depreciation on the dwelling by dividing its value by 27.5.
$80,000 ÷ 27.5 = $2,909.09
In this example, the depreciation allowance is $2,909 per year.
If you rent the property for $800 per month and your mortgage is $600 per month, you have a positive monthly cash flow of $200 or income of $2,400 per year.
Your income is now offset by the depreciation expense ($2,400 – $2,909 = -$509). In this example, for tax purposes, you lost $509 on this property. This is a “paper loss” only, as you actually made $2,400.
So you receive monthly cash flow, you depreciate the property for tax write offs, and if you purchased correctly, you receive the added benefit of “appreciation” as the property value increases over time! I love real estate.
You can further maximize the depreciation by doing what is known as “componentizing,” commonly known in accounting circles as “segregated” depreciation. This allows you to break out certain components of the property and depreciate them separately. For example, carpet, appliances, HVAC, and roof may be broken out and componentized as personal property which can be depreciated even faster over only five years. Check with your CPA to see how you can implement componentization into your business structure.
Landlording is a time-consuming, expensive, extremely detailed, highly regulated venture and you earn all the tax benefits you’re allowed. Know what the law allows you to claim and claim them. There are so many benefits, but you must educate yourself to know what they are.
For complete information on tax deductions for landlords, visit IRS Publication 527 at IRS.gov and be sure to check with your CPA to find out all the tax advantages available to you.
What can you add to the conversation about tax benefits of depreciation?
Sep 16th, 2019 / 10:58 am
Hi Julie:
I don’t know enough about taxes or law to attempt any of these processes on my own. Therefore, I recommend a real estate attorney to properly set up your entities (LLC, SCorp, partnerships, etc.) rather than doing anything yourself.
And, you need to work with a real estate CPA who understands tax code and what deductions you’re allowed to take and how.
Cost segregation is amazing and really helps, especially when just starting out. Look for those who can help you set things up properly. It will be more costly up front, but so worth it in the long run.
Thanks for asking and good luck to you!
Sep 15th, 2019 / 8:31 am
Karen, This is exactly the information I am seeking. Do I really need to pay a licensed appraiser that specializes in cost segregation to apply this to my rental properties? I have 10 similar rental properties in the same area that are roughly the same size and are all 3 bed /2 bath and around 1500- 2000 sqft. Seems like flooring, roof, HVAC, etc. are all pretty standard costs. Can’t I apply cost segregation myself (especially if it’s the first year and I’m setting up the books for that asset for the first time?). I 4 new ones to do this year, so this would be very helpful to know right away! Thank you for your advice!
Jun 12th, 2014 / 8:07 am
So true, Connie.
Thanks for taking the time to leave a comment!
Jun 12th, 2014 / 8:07 am
You’re welcome, Eunice!
Oct 1st, 2013 / 10:39 am
Awesome and informative for any investor. I too love real estate. Thanks for the post on tax deductions. If most Americans knew how much they could offset their taxable income, they’d love real estate as much as we do. I cringe when I hear what some people pay in taxes. Buy rental property folks, it’s a great way to gain wealth. (As long as you take advantage of tax deductions)