How Real Estate Investor Benefit From Depreciation
Depreciation is a non-cash expense that allows investors to deduct the cost of property over time. Based on normal wear and tear depreciation can help reduce taxable income recognized by a taxpayer.
How Real Estate Depreciation Works:
- The IRS assumes that buildings wear out over time, so it allows investors to depreciate the building’s value, not the land.
- Residential property is depreciated over 27.5 years.
- Commercial property is depreciated over 39 years
Example:
You buy a rental property for $300,000
- Land value: $50,000 (not depreciable)
- Building value: $250,000
Annual depreciation:
$250,000 ÷ 27.5 = $9,090.91/year
This $9,090.91 can be deducted from rental income each year, reducing your taxable income.
Why Investors Love Depreciation:
- Reduces Taxable Income
- Even if the property is cash-flow positive, depreciation can create a paper loss and reduce taxes.
- Boosts Cash Flow
- Less tax paid = more money in your pocket.
- Offsets Other Income (In Some Cases)
- Real estate professionals may use depreciation losses to offset other earned income.
- Cost Segregation Can Accelerate Depreciation
- You can break the property into components (e.g., appliances, flooring) and depreciate some over 5, 7, or 15 years instead of 27.5 or 39.
Depreciation Recapture
When you sell the property, the IRS may "recapture" the depreciation you claimed and tax it at a higher rate (up to 25%). But investors often plan for this using 1031 exchanges or strategic tax planning.
Summary:
| Benefit | Description |
|---|---|
| Reduces taxable income | Lowers taxes on rental income |
| Increases cash flow | Keeps more money in your pocket |
| Delays taxes | Puts off some tax burden until salece |
| Can be accelerated | Use cost segregation to frontload deductions |