Most people who have tried to sell their old car or any other asset are aware of the term “depreciation.” Simply put, depreciation refers to a decline in asset value over time. For instance, when you purchase a new vehicle, its value depreciates the minute it is driven off the lot.
Depreciation in real estate investing
In the context of real estate investment, depreciation is a valuable tool and is considered to be the investor’s best friend. It enables property owners to deduct the costs of depreciation from their taxes linked to buying and renovating their property, which helps lower their taxable income. The assumption behind real estate depreciation is that the property loses its value over time due to wear and tear.
As a non-cash deduction, the benefits are not in terms of actual cash but rather in terms of reduced taxable income.
For real estate investors who rent out their property, the advantages are not limited to collecting rent and/or making money from a property sale in the long term. The depreciation cost offers compelling tax incentives as well.
How to calculate depreciation?
For assets that have a useful life of a year or more, depreciation is deducted over a period of time. It is important to note that when calculating depreciation, only the building’s value is taken into account and not the land it is built on.
For real estate assets, the IRS has set guidelines for calculating depreciation value. The IRS says useful life of commercial properties is 39 years. Any multifamily building with 5+ units is considered a commercial property.
A simple example:
Let’s say you purchase an office property for $2 million and the appraised value of the land is $600,000. This gives you a building value of $1.4million. Dividing this amount by 39 gives you a $35,897 depreciation expense for every full year you own the property. During the first year of ownership, the IRS provides guidelines on how to prorate the deduction.
Rules of depreciation
The IRS Publication 527 lists several criteria that have to be met for depreciation of rental property:
- You must be the owner of the property
- The real estate property has to be used to obtain income from tenants typically.
- Useful life of the property must be determinable
- The rental property’s useful life must be more than a year
Hi, my name is Michael Avent. I founded The Multifamily Review in 2020. I’m a Commercial Agent at Northcap Multifamily located in Las Vegas, Nevada. My vision for The Multifamily Review is to be the most trusted resource for all Multifamily Investors and Industry Professionals. We strive to offer the best and most up to date content to our readers and are always open for suggestions. Make sure you sign up to join our newsletter to stay up to date on our latest blog, ebook, and more exclusive content that’s coming your way! The Multifamily Review team and I look forward to building a deeper relationship with you!
Subscribe to our community Newsletter!