Real estate is often viewed as a lucrative investment opportunity because of its potential to appreciate in value over time. However, another often overlooked benefit of owning real estate is depreciation.
Depreciation is a tax deduction that allows property owners to deduct a portion of the cost of their property from their taxable income each year. The idea behind depreciation is that a property will lose value over time due to wear and tear and other factors, so the owner should be allowed to deduct some of that loss from their taxes.
For real estate investors, this can be a significant benefit. For example, let's say you purchase a rental property for $500,000. You can deduct the cost of the building over a 27.5-year period, which means you can deduct $18,182 per year from your taxable income. This can result in substantial tax savings over time. We also suggest on many projects it makes sense to get a cost segregation study done to maximize the amount of tax savings. See our article about cost segregation studies here.
Depreciation is also beneficial because it is a non-cash expense. This means that the deduction does not require any actual money to be spent, unlike other deductions such as mortgage interest or property taxes. This can help free up cash flow for real estate investors, allowing them to reinvest the money back into their properties or use it for other investment opportunities.
Depreciation can help offset rental income from your property. Rental income is subject to income tax, but depreciation can help reduce the taxable amount. For example, if your property generates $30,000 in rent per year and you deduct $18,182 in depreciation, you would only be taxed on $11,818 of rental income.
It's important to note that there are some limitations to depreciation. The deduction is only available for the improvements on the land meaning structures that have been built, not for the land it sits on. Additionally, if you sell the property, you may be required to recapture the depreciation and pay taxes on it at the time of the sale.
Depreciation is a significant benefit of owning real estate that can help reduce taxable income and free up cash flow for investors. While it's important to understand the limitations of depreciation and consult with a tax professional, it is a valuable tool in the real estate investor's toolbox.
To learn about investing with Forza Capital, register for our online investor portal here.
Comments