Don’t you love depreciation?
Depreciation is easily one of my favorite benefits of real estate investing, but it is often misunderstood.
Basically, depreciation is the tax benefit that the IRS allows for “wear and tear” of investment property. The IRS says that rental real estate lasts 27.5 years (or 39 years for commercial real estate), so they allow you to deduct a portion of the building purchase (not land) over its recovery period. Investors claim this deduction each year without paying any more than the original down payment. And they get to claim the deduction even if the property appreciates in value (which it usually does).
Let’s take a very rough example.
Let’ say you purchase a $650k property. Assuming the building component is $550k, that means you’ll deduct $20k of depreciation expense. Every year. For 27.5 years.
So, if the annual net income from the property is $20k or less, you can reduce that by the $20k of depreciation expense and pay no income taxes on that investment!
Contrast that to the amount of taxes that you likely pay on $20k of a W-2 job, and you soon start to realize why this is such a powerful tax benefit of real estate. And when you scale up into larger real estate deals, the benefit is multiplied exponentially.
All of this is considered normal, everyday depreciation. There are additional benefits with accelerated and bonus depreciation. That’s where cost segregation comes in.
As a disclaimer, there are multiple factors to consider along with depreciation, so it’s always recommended to consult your tax professional.