One of the first advantages that people will bring up in a conversation about real estate are the tax deductions. Real estate is known by everyone to be an outstanding investment for reducing taxes, but many people do not understand why that is the case. Today we will talk about depreciation which is the first step to understand how real estate can help with your taxes
Deprecation is based on the concept that any physical object will depreciate over time. This is true of roads, cars, boats or in our case buildings. The IRS recognizes that each year you use a building to generate income it will incur a certain amount of wear and tear. For the purposes of their calculations, a multifamily building is assumed to go from full value to zero value across a period of 27.5 years due to this wear and tear. Therefore, if you had a building worth $1,000,000 it would lose 1/27.5 of its value each year or $36,366.
What’s important to understand is that although this is the legal paper loss for your building, the actual value of the building has probably increased due to appreciation and performing maintenance which is also tax deductible. This results in a net gain for the investor who can use this paper loss to reduce or eliminate the income taxes from the property (or other passive investments) even though it is really increasing in value. While the building as a whole is depreciated over 27.5 years there are other parts of the property (like appliances, flooring, parking, etc.) that actually can be depreciated at a much faster rate. The process of categorizing these items and calculating the total depreciating is called cost segregation and it will be the topic of next week’s article.
If you would like to talk with us about investing in multifamily real estate, please feel free to schedule a meeting with us at here.