Does real estate depreciation conjure up positive or negative thoughts for you? To most novice investors, depreciation probably sounds negative, but it’s actually a way to maximize your rental property’s profits by deducting purchase and renovation costs. In fact, knowledgeable investors use rental property depreciation as a steady path to profitability.
Depreciation is essentially a tax deduction for property owners, though it does work a little different than most. In most cases, when you have a business-related expense, you can get a large deduction for that expense at the end of the year. The following year, however, that expense no longer gives you a deduction because you had a break the year before. In the case of property depreciation, you can go about it a bit differently. Instead of taking one significant deduction the year of the purchase or improvement of the property, you can distribute the deduction throughout the useful life of the property. Of course, the internal revenue service has a series of rules that apply to depreciation, and it is important to have an understanding of said rules, in addition to consulting with a tax professional.
You may depreciate a property provided it meets specific requirements. You must own the property and use it as an income producer. You can determine what its useful life will be. In other words, it is something that wears out, and over time, becomes obsolete, losing some of its value. The property’s useful life must be longer than a year. Finally, you must not have disposed of it during that year. Keep in mind that land is not depreciable. Some good examples include improvements like new appliances, new carpets for the floor, and other enhancements that will deteriorate over time.
The simplest way to calculate rental property depreciation is by deducting the estimated value of the cost and then dividing it by the useful life of the improvement. Say you get new appliances and spend $10,000, and its useful life can be estimated to be 10 years at the end of which the value of these appliances will drop to $1,000. Subtract that $1,000 the appliances will be worth from the initial cost of $10,000 and divided it by its useful life, in this case 10, leaving you with $10,000-$1,000 = $9,000/10=$900, so the annual depreciation expense would be $900.
You can improve your rental property using investment property depreciation and have the IRS foot the bill or part of it. You spend the money out of pocket at first, but as you continue receiving tax breaks year after year, it basically pays for itself. Not only are these improvements paying for themselves, but now your property is worth more, and potential tenants will be more likely to rent from you. That means more money in your pocket.
If you’re looking to maximize your rental property’s profits through residential rental property depreciation, consult Optum Real Estate Management. We have an experienced team that can expertly take you through the investment process. Give us a call for a free consultation at (949) 478-4695.