
WHAT IS DEPRECIATION?
Real estate investors can claim a tax deduction for the decrease in value of improvements on their investment property, known as depreciation. As per the Internal Revenue Service (IRS), it is a provision for the property's deterioration, wear and tear, or obsolescence. It is important to note that only the value of the improvements made on the land is eligible for depreciation, and not the value of the land itself. HOW IS DEPRECIATION CALCULATED? To illustrate, let's consider a scenario where the total value of an investment property is $1,000,000, with the land value being $200,000. Although the tax deduction can be claimed for the remaining value of $800,000, it cannot be taken in its entirety in the same year of purchase. Instead, it must be spread out over 27.5 years for residential property or 39 years for commercial property. To determine the precise amount of depreciation, your CPA will utilize a specific formula based on the month you acquire the property. For further information, refer to IRS publications 527 and 946. HOW CAN YOU BENEFIT? Claiming the tax deduction for depreciation upon buying a rental property in real estate enables you to avail of a "paper loss" against the improvements' value, thus protecting a portion of your rental income from taxation. However, there's a catch since you'll have to pay "depreciation recapture" tax upon selling the property. Nevertheless, there are methods to defer this tax as well, such as employing a 1031 Exchange. To learn more about this, refer to my article on 1031 Exchanges.
PLEASE NOTE: THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL, TAX, OR FINANCIAL ADVICE. PLEASE CONSULT WITH A QUALIFIED TAX ADVISOR FOR SPECIFIC ADVICE PERTAINING TO YOUR SITUATION. FOR MORE INFORMATION ON ANY OF THESE ITEMS, PLEASE REFERENCE IRS PUBLICATION 946 and IRS PUBLICATION 527.
Source: Momentifi
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