Real Estate Depreciation Explained

What is Real Estate Depreciation?

Real estate depreciation is a joint strategy property owners use to lower their tax burden. When you own a property, the IRS allows you to claim a depreciation deduction to reflect the wear and tear on the property over time. This can be a significant benefit, especially for investors who own multiple properties, as it can save thousands of dollars in taxes each year.

Real property depreciation is an income tax deduction allowing taxpayers to recover the cost of certain real estate investments over time. It allows owners to write off a portion of the cost of a property each year, based on its useful life.

How to Calculate Real Estate Depreciation

To understand how real property depreciation works, let’s look at an example. Imagine you own a rental property that you bought for $300,000. Over the years, the property has appreciated in value, and it’s now worth $500,000. However, the building itself has also aged, and its value has decreased or depreciated.

To calculate the depreciation deduction, you need to determine the property’s basis, or its original cost. In this case, the property’s basis is $300,000. You also need to determine the property’s useful life, which is the amount of time the IRS expects the property to last before it needs to be replaced. For residential rental property, the useful life is typically 27.5 years.

Based on these figures, you can calculate the annual depreciation deduction using the following formula:

Depreciation deduction per year = (Property basis) / (Useful life of the property in years)

In our example, the annual depreciation deduction would be:
Depreciation deduction per year = ($300,000) / (27.5 years) = $10,909 per year

This means that each year, you can claim a deduction of $10,909 on your taxes for the depreciation of the property. Keep in mind that this is only an example, and the actual deduction you can claim may be different based on your specific circumstances.

Depreciable Property Examples

Examples of real estate depreciable property include:

  1. Land Improvements – These are physical improvements made to land, such as a fence or driveway, that add value to the property. Land improvements can be claimed for depreciation over the years, reducing your tax bill.
  2. Buildings – Any buildings on the property are considered depreciable and can be deducted from your taxes over time. This includes single-family homes, multi-family buildings, office buildings, and industrial buildings.
  3. Equipment – Any equipment used as part of a real estate business can be claimed as a deduction, including furniture, appliances, and tools used in maintenance or repairs.
  4. Improvements – Improvements to the property, such as renovations or remodeling, can also be claimed as depreciable property, reducing your taxes over time.

By claiming these depreciable properties, you can reduce the taxable income and lower your tax rate.

Does Depreciation Reduce Tax Liability?

Depreciation reduces a company’s taxable income by allowing businesses to write off the cost of purchasing certain assets over some time. For example, a business may buy a piece of equipment for $50,000 and choose to depreciate it over five years. In this case, the industry could deduct $10,000 per year from its taxable income for the next five years. This would reduce the company’s tax liability by reducing their taxable income and, thus, their tax bill.

How long can real estate be depreciated?

Real estate can be depreciated over 27.5 years for residential real estate and 39 years for commercial real estate. The Internal Revenue Service (IRS) determines the period of depreciation.

What are the two types of depreciation in real estate?

There are two types of depreciation in real estate:

  • Curable depreciation is damage or wear and tear that can be reversed or repaired. This type of depreciation is caused by factors such as poor maintenance, outdated appliances, and general aging of the property. Common examples of curable depreciation are a roof needing replacement, an HVAC system that needs to be serviced, or outdated appliances that need to be replaced.
  • Incurable depreciation is damage or wear and tear that cannot be reversed or repaired. This type of depreciation is caused by factors such as location, construction defects, or zoning restrictions. Common examples of incurable depreciation are a home located in a flood zone, an area with high crime rates, or a property with an inadequate septic tank. In these cases, the property will never regain its original value and must be sold for a lower price than it would have if the issues had not been present.

Important Things to Keep in Mind

There are some important things to keep in mind when using real estate depreciation to lower your taxes. First, you can only claim the depreciation deduction if you are the property’s owner and you are using the property for business or rental purposes. Second, the property must be held for more than one year to qualify for the deduction. Third, the depreciation deduction is considered a paper loss, which means it can only be used to offset income from the property, not other sources of income.

Despite these limitations, real estate depreciation can be a powerful tool to save on taxes. By claiming the depreciation deduction each year, you can reduce your tax liability and keep more of the income from your rental property. It’s important to consult with a tax professional to determine the specific deduction you can claim and how it will affect your taxes.

Next Steps

In conclusion, real estate depreciation is a valuable tax strategy for property owners. By claiming the depreciation deduction each year, you can lower your tax burden and keep more of the income from your rental property. It’s important to understand the rules and limitations of the deduction and to consult with a tax professional to maximize its benefits.

Keep reading our post on why real estate is an appreciating asset and how to take advantage of it. Or reach out to us if you have any questions!

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