The Power of Depreciation

• 🏘 27.5 years for residential property

• 🏢 39 years for commercial property

  
  

This non-cash expense effectively lowers taxable income, which can be particularly advantageous even when an investor is generating strong cash flow from their properties. The beauty of depreciation lies in its ability to provide tax relief without requiring any actual cash outflow, allowing investors to retain more of their earnings.

Example: Consider a rental property generating $20,000 annually in positive cash flow. Despite this seemingly robust income, once depreciation is factored into the equation, the property may still show a taxable loss. This “loss” can be utilized to offset other income, thereby reducing the investor’s overall tax burden and enhancing their financial position.

However, it is important for investors to be aware of the implications of depreciation recapture when they decide to sell their property. The IRS may apply depreciation recapture, which can increase the taxable gain from the sale of the property. This means that investors could face a higher tax bill upon selling their appreciated assets. To mitigate this tax liability, smart strategies such as a 1031 exchange can be employed, allowing investors to defer the tax consequences by reinvesting the proceeds into a similar property. Furthermore, renovations and improvements made to the property can also be depreciated, which can further enhance the deductions available to the investor, ultimately providing even greater tax savings.

Action: It is advisable for investors to review their depreciation schedule annually with their CPA. This regular assessment ensures that all eligible deductions are being captured and that the investor is fully leveraging the benefits of depreciation in their overall tax strategy. By staying informed and proactive, real estate investors can maximize their tax savings and optimize their investment returns.