Seasoned real estate investors know there are many advantages to owning income property; benefits like cash flow, principal pay down, and tax deductions for loan interest and depreciation.
Most new investors are familiar with all of those terms except depreciation. So, what is it? Well, it’s an accounting term that basically says assets wear out or get used up over a period of time. Depreciation is a way to spread the purchase cost of something over the number of years it’s expected to last before it finally wears out.
Understandably, different kinds of things have different lifespans. A refrigerator, for example, has a shorter lifespan than oh, say, a garage. Therefore, it has a faster depreciation schedule. Land, on the other hand, never gets used up. I hate to be the bearer of bad news, but even if greenhouse gas gets the best of us, the land will still be here. We won’t.
Somewhere along the line, Congress, the accountants, businesses, and I suppose, even the I.R.S. got together and decided that if you’re going to invest in America — through real estate, or a business, you should get a break on your taxes. Collectively, they came up with something called a depreciation schedule for four different categories. The categories are:
Then the grand poobahs decided each category could deduct a certain percent of the depreciable value every year. All legit. All okey-dokey with the I.R.S. Well, as long as you’re honest about it.
Of course, for the finite details, you should consult an accountant.
So here’s something a lot of the bigger investors don’t know. If you, the owner occupy a multi-family property like a duplex, you can depreciate and write off the part you don’t live in. And no, you can’t do that when you live in a house.
Too good to be true, right? Yes, of course, there’s a caveat. If you sell your investment property and cash out, there will be tax consequences. Capital gains tax, of course, if the property went up in value. And something called depreciation recapture. In other words, the government wants the money you deducted from your taxes back. Ugh.
Aw, c’mon. You know guys like Donald Trump wouldn’t stand for that kind of thing without a loophole. The loophole’s called a Starker or 1031 Exchange. And I’ll talk about that later.