Understanding Rental Property Depreciation and Taxes
Summary: When buying investment properties, most people focus on the cash flow. However, there are greater benefits that are sometimes overlooked – rental property depreciation and tax benefits. It can get complicated but we want to lay it all out for you.<br> Rental Property Depreciation<br> Depreciation is the loss in value to a building over time due to age, wear and tear, and deterioration. You can also include land improvements you’ve made and items inside the property that are not part of the building like appliance and carpeting.<br> Simply put, rental property depreciation allows investors write off the structure and improvements to the property over a period of time. This is an “expense” that you can use as a write-off on your taxes.<br> However, you can only depreciate the improvements to the structure itself -not the land.<br> Depreciation is one of the biggest benefits to <a href="https://www.listenmoneymatters.com/go/roofstock/">real estate investing</a> because it can reduce reportable net income and therefore, your taxes.<br> <br> Calculating Depreciation<br> Basically, the IRS allows owners to take a tax deduction based on the perceived decrease in the value of the property over a period of 27.5 years. <br> Depreciation deductions are spread out over the “useful life” of a property. The IRS allows an owner to depreciate the value of the home over a 27.5 year period. Depreciation is calculated with this formula:<br> Cost of the Building- Value of the Land = Building Value<br><br> Building Value / 27.5 = Yearly allowable depreciation deduction<br> It would look like this for a property worth $75,000 and land worth $25,000;<br> $75,000 – $25,000 = $50,000<br><br> $50,000 / 27.5 = $1,818<br> Cross Segregation<br> Landlords usually depreciate all of the things that can be depreciated, together with over the 27.5 year period. That’s a long time. What if you want to speed things up? You can use a method called cross segregation.<br> Rather than grouping all the items together, you can depreciate them individually.<br> It’s more complicated to do so and requires a lot of detailed record keeping but it means a bigger total depreciation each year for the first several years you own the property.<br> Personal property and land improvements have shorter depreciation periods than the building itself, usually, five or seven years so can be depreciated on an accelerated schedule.<br> The total deduction doesn’t change but you get it more quickly; you get them upfront rather than on the back end.<br> Why would you want to do that? Because if you take that money and invest it, it will have more time to grow and there is no substitute for time when it comes to growing money through investing.<br> This is all too complicated for you to do on your own but you can hire someone to do it for you. It can be pricey though so unless your property is valued at more than $250,000, it’s probably not worth the cost.<br> <br> Passive Losses<br> It’s common to have losses on a rental property in the first few years. Losing money on an investment is a bad thing but in the case of rental property, it can have tax benefits.<br> You have a loss if the total operating expenses for your rental are greater than the yearly rent you make on it.<br> You can even have a loss for tax purposes if your rental income is more than your expenses because you can deduct a certain amount of depreciation on your rental every year.<br> Passive losses can only offset passive income, you can’t deduct them from income you earn at your job for example.<br> If you don’t have enough passive income, the rental losses are in limbo. You can’t deduct them until you have a sufficient amount of passive income sometime in the future or until you sell the property. Because those losses can sit there for years, you have to plan properly or you can lose your l...
