If you are new to real estate investing you know that there are many ways to profit through real estate investing. Of course there is cash flow and loan paydown from tenants paying their rent, but let’s not forget that real estate also have huge tax advantages.
Landlords have the ability to write off expenses that occur when renting out residential and commercial real estate. In addition to write offs, landlords also can depreciate their assets over the lifespan of the property. So what is depreciation?
This blog post will discuss the benefits of depreciation and how it helps real estate investors keep most, if not all, of their cash flow.
What is Depreciation?
The Internal Revenue Services (IRS) defines depreciation as a capital expense. It is the mechanism for recovering your cost in an income-producing property and must be taken over the expected life of the property
Depreciation is only available for landlords who are renting out their property or planning to rent out their investment property. So if you are a fix-and-flip real estate investor, you will not be eligible to depreciate an asset which you plan to sell immediately.
How Depreciation Works?
Typically, depreciation can be used for both residential and commercial properties. Residential properties have a useful life of 27.5 years, while commercial properties can be depreciated over 39 years. Based on the useful life of your property, you will be eligible for a yearly tax deduction of the Purchase Price of Property / Useful Life of Property.
For example, let’s say you own a residential property and the depreciable cost basis is $400,000. This would give you a $14,545 annual depreciation expense. After one year of ownership, this would reduce your cost basis to $385,455. After two years, it would reduce your cost basis to $370,909. And after 27.5 years of ownership, your cost basis would effectively be reduced to zero unless you made capital improvements along the way.
So if your property doesn’t produce more than $14,545 of pure cashflow (after paying the mortgage and other expenses) you would not own any addition income taxes on the rental income to the IRS. This is exactly how real estate can produce tax-free money!
Depreciation & House Hacking
If you are house hacking, you can still claim depreciation however you can't claim depreciation for the entire asset. Since depreciation is typically claimed for the lifespan of the entire property, since part of the property is your primary residence you cannot claim it over the entire percentage of your home.
It is recommended that you talk to a certified public accountant (CPA) who specializes in real estate if you are trying to claim depreciation for a house hack. A CPA will ensure that you are able to get the full tax benefit without placing yourself in any legal troubles.
In conclusion, depreciation is by far one of the most powerful tax advantages real estate investors used to gain tax free rental income. If you are an investor, and have not started depreciating your asset, please consult a CPA so that you too can capitalize on this amazing opportunity.