is a loss in the value of an asset over time
. The Federal tax code allows owners to take a deduction
for depreciation on assets used for business purposes (like real estate investment property) each year to offset investment income and/or ordinary income. Depreciation can be taken for buildings, machinery, appliances, furniture, fixtures, cars, computers, anything with a useful lifespan of over 1 year
, that does not last indefinitely, and is used for business
Everything ages over time from wear and tear and frequent use; there is a corresponding drop in asset value the more the asset is used. Eventually, the asset wears out and reaches the end of its useful life and needs to be replaced. Depreciation is a theoretical tax method the Government uses to account for an asset’s loss in value. It is important to note that Depreciation is a theoretical tax method and not an actual appraisal of value. For tax purposes, the value of real estate at the end of its depreciable life of 27.5 years (Residential) or 39 years (Commercial), is zero or no value, while in reality, houses, duplexes, and apartment buildings last longer than that and still have actual value.
It is important to note, Depreciation is a deferral of tax, not forgiveness. Some Investors who are selling their first investment property are surprised by a larger than expected tax liability for a sale. Everyone always remembers Capital Gains Tax, but the first time investment seller often forgets to consider Depreciation Recapture Tax (see below) also.
One other general note I’d like to make about Depreciation is that whether you use it or not on your annual income tax filings when you sell, the government assumes you took depreciation- so you still have to pay depreciation recapture tax! So if you own an investment property, make sure you are taking your depreciation each year. If you don’t use it you lose it.
Investors love depreciation because it is one of the X benefits of owning real estate and provides hefty tax deduction which increases the investment property’s after-tax cash flow or provides a tax shelter for the owner’s personal income.