DEPRECIATION: ANOTHER REASON REAL ESTATE INVESTMENT IS THE BEST WAY TO MAKE YOUR MONEY WORK FOR YOU
There are very few ways to build wealth more consistently and reliably than investing in rental property. Although it may not be readily known, real estate is one of the most tax advantaged asset classes in the country and it’s unfortunate that most people aren’t educated about these massive financial opportunities. Smart real estate investors want to make sure they understand tax code and their tax liability so they can maximize their profits. There are several ways you can decrease your overall tax liability while building equity in a rental property. Recently, Nexus expanded on this in this article about the right approach to thinking about maintenance expenses. As you’ll recall, maintenance expenses can be written off against any profits you make. The same holds true for mortgage interest, insurance, and property taxes. Ultimately, it’s in your best interest to work with a licensed accountant, but it’s also important that you personally understand the opportunities that exist for rental property owners. Deducting depreciation is another one of those opportunities.
WHAT IS DEPRECIATION?
The value of property (in general) naturally decreases over time due to inevitable wear and tear. There’s the old quip that the value of any brand new car drops by thousands of dollars the moment you drive it off the lot. With that principle in mind, rental property owners can claim “depreciation”, or lost value over the year, when it’s time to file taxes. This is unique. You don’t have that opportunity when it comes to that brand new car, or other personal property.
Your rental property has a discernible useful life, or a period it is expected to be able to generate revenue, and the government allows you to use this calculation to estimate how much the value of your property has depreciated. Each year, you are able to deduct that estimated depreciation from your rental property profits assuming the property is in service. If your property is functional and able to be rented, it meets the conditions to claim depreciation. You cannot claim depreciation for a property that isn’t in marketable shape or if it will not be used to generate income. It’s also important to note that land value is not included in calculating depreciation. While structures naturally weather over years, it’s accepted that land value will not erode as it is not “used up” and will remain intact going forward.
LEARN MORE: WHY RENTAL PROPERTY DEPRECIATION IS AN INVESTOR’S BEST FRIEND
BURYING THE LEAD: YOU’RE NOT ACTUALLY LOSING VALUE
Real estate investors are fortunate to be able to claim depreciation each year because it helps offset profits and natural deterioration of their property…but there’s something really important that hasn’t been mentioned yet. Unlike that car that drove off the lot, the value of your rental property doesn’t actually decrease; in fact history tells us that over the medium and long term, the value is going to increase dramatically. While the government is giving you a break for lost value, you’ve been building equity through collected rent and odds are very good that the value of your property has actually increased.
Photo credit: Federal Reserve Bank of St. Louis
LEARN MORE: THE BASICS OF RENTAL PROPERTY TAXATION
CALCULATING DEPRECIATION
The easiest way to figure out your depreciation is to go to your tax assessor’s website but as local governments go, it’s not always accurate. An in person visit, if available, will give you the opportunity to ask clarifying questions and ensure the latest shared records are up to date.
Otherwise, depreciation is typically spread out at 3.63% over 27.5 years, where 27.5 represents the expected useful life of the structure. To use nice round numbers, let’s say you bought a two-family home for $200,000 and the land is worth $50,000. With an income generating home valued at $150,000, you can claim $5,455 as depreciation against your taxable income. In the same way you can write off other related expenses, depreciation is another bonus that the government allows that should make it easier for you, as a property owner, to maximize your profits and the value of your assets.
LEARN MORE: IT’S YOUR CHOICE: INVEST BY ADDING VALUE THROUGH MAINTENANCE, OR PASS YOUR PROFITS OFF TO UNCLE SAM
NEXT STEPS
As a professional property manager, it’s Nexus Property Management’s goal and responsibility to help educate property owners and prospective property owners for the sake of improving investment opportunities for all. Real estate investment is an avenue for investors of all ages and backgrounds and it’s our hope that the recent uptick in hiring professional property managers will continue. There is no doubt that having a professional in your corner, regardless of the arena, is the best way to maximize results. Reach out to the Nexus team closest to you.
LEARN MORE: NEXUS’ GOAL OF REBRANDING THE PROPERTY MANAGEMENT INDUSTRY
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Mick Lefort is the Vice President of Operations for Nexus Property Management®. A National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.
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