There are a number of tax advantages accrued to owning a rental real estate. It turns out, many investors don’t understand the tax advantages, such as real estate depreciation. The term real estate depreciation will rarely miss out on real estate investing discussions.
What is real estate depreciation?
Real estate depreciation refers to an income tax deduction due to depreciation on the value of a property. Essentially, depreciation reduces the amount of income tax paid by a real estate investor. Why is it commonly referred to as “phantom” expense? Well, there is no physical check written hence the term. Investors are allowed by the IRS to take a tax deduction following a drop in the value of a real estate property.
Real estate depreciation is an important aspect of real estate asset management that allows for turning property depreciation into an advantage. Depreciation is usually not a good thing as it reduces the value of a property. For instance, a car will more likely to depreciate over time and if you were to sell it two years later, you will sell it at a price lower than you bought it. However, depreciation can be used as an advantage to a real estate investor.
Depreciation in the real estate assumes that the value of a real estate property declines over time because of tear and wear. Contrary to that, it is not always the case. Not many investments offer comparable tax deductions as a result depreciation. An investor can maintain cash flow while at the same time showing a tax loss in the real estate industry.
A good scenario is an appreciation of the value of an apartment complex and a depreciation on the value of a building. Generally, the value of an apartment complex can increase over time, while the value of the building can decrease over time. When the apartment complex appreciates, it creates more equity for the owner. When a building depreciates, it reduces its tax basis. Consequently, there will be a reduction on the taxes paid on simultaneously appreciating assets.
Why is it important to show a real estate property tax depreciation?
Investors show their real estate property tax depreciation to reduce their tax burden subject to some limitations. Consequently, investors in the industry save thousands of dollars every year on taxes.
Properties that can be depreciated
There is no denying that depreciation is one of the biggest perks of real estate investing. There are a few requirements that can easily be met to be eligible for depreciation. First, you must be the owner of the real estate property, and capital improvements for property the investor leases may also be depreciated.
Secondly, the property must be used commercially. If the property is for both personal and business use, an investor will only get tax deductions on the part used for business. Lastly, the real estate property should have a beneficial life that is determinable and exceeds one year.
A closer look
One property that is not depreciable is land. However, if you own a real estate property, such as a rental property, the building can be depreciated. You can also depreciate huge improvements, as well as equipment used in the property’s operation. Depreciation starts when a property is placed on service and ends when it is removed from service, or rather disposed or retired. Depreciation on the property or its aspect will reduce an investor’s basis on the property. The depreciation is recaptured when the property is disposed of.
The United States real estate is a multi-billion dollar industry. Nevertheless, the investors who understand the sector’s perks survive in the competitive market. As much as it is a huge industry, many entrepreneurs fail to get to their feet for lack of enough knowledge on how the sector operates. Therefore, any aspiring real estate investor should adopt an “out of the box” approach to real estate business and not overlook some elements such as real estate depreciation.
Real estate investors should not overlook real estate depreciation as it is a critical tax deduction. Real estate investors should go out of their way to learn depreciation basics. It will go a long way to help them understand after-tax investment returns. The industry is now booming as properties continue to be developed.