Maximize Your Property Profits with Real Estate Depreciation Strategies

With more and more people preferring to rent a property rather than owning one, buying real estate has become a savvy choice for many investors. That said, taxes can cause several complications, making you feel like you are losing more than you are earning.

This is where depreciation (or amortization) in real estate comes in. Deducting taxes from the improvements and overall building value can boost your returns by reducing taxable income. Tools such as the REI Lense calculator can be helpful in these circumstances, and this article will tell you how you can do that.

What Is Depreciation in Real Estate?

The amortization definition in real estate is more or less a reward you receive for your property’s rear and tear. This usually occurs when the property loses its value, and it’s a tax-saving tool that can help you make smaller payments to the IRS. While house flippers might not benefit as much, as they make a profit from selling homes, it can be a money-saving tool for those who rent out.

Depreciation is calculated in two ways, resepctively:

• Straight-Line Depreciation Real Estate: The most common method, which deducts the same sum every month.
• Accelerated Depreciation Real Estate: Allows you to claim significant deductions early on, offering timelier tax savings.

Land is not depreciated, but buildings can, especially after you make significant modifications to them (e.g., kitchen renovations or a new roof). The IRS assumes a specific longevity for different types of buildings, with residential properties being divided over 27.5 years and commercial properties over 39 years.

At What Point Does Real Estate Depreciation Begin?

Many investors believe that amortization in real estate starts when you buy the investment property, but that’s not true. It can hold the same value for a long time, provided you don’t make any changes to the home and don’t get rental income.

For instance, let’s say you purchased a house and stayed there for a couple of months, during which time you handled renovations. In this case, the property will not depreciate because it is not producing any income yet.

That said, it will begin depreciation when you finish renovations and it’s ready for rent. If you buy the property on March 15 and make it available for rent on May 15, the depreciation will begin at the latter date. It doesn’t matter if it’s vacant or not; if it’s ready for generating income, it’s eligible for amortization.

How to Calculate Depreciation on Real Estate

Learning how to calculate depreciation is easy as long as you have an eye on the start and endgame. A good idea would be to begin putting some data in your amortization table real estate. After that, you can follow the steps below:

1. Determine the Property Value

To find the actual value of the property, you will have to subtract the value of the land from the total purchase cost. This is essential because the land cannot be depreciated; only the man-made property that sits on it.

2. Use IRS Depreciation Period

Next, you’ll have to apply the depreciation period set by the IRS (27.5 years for residential properties and 39 years for commercial). Next, divide the property’s value by the depreciation period. The result is the amount you can deduct from your annual taxable income.

3. Adjust for Partial-Year Depreciation

If you buy the house throughout the year, you also need to adjust the first year of depreciation based on the available months. For instance, if you rented the property out in June, the first year of depreciation should only have 6 months.

4. Factor In the Property Improvements

When calculating depreciation, don’t forget to include modifications such as an updated electrical system. Depending on how significant the changes are, the depreciation period can last anything between 5 and 15 years.

5. Calculate Total Deductions and Tax Savings

Lastly, add the depreciation to other expenses such as mortgage interest, management fees, and repairs. This can give you a more comprehensive view of what you have saved. A mortgage calculator such as the one offered by REI Lense can be very helpful to simplify these calculations.

Benefits of Depreciation in Real Estate

Depreciation brings a series of advantages for those planning to invest in real estate, including the following:

Taxable Income Reduction

With depreciation, you write off a certain percentage of the value of your building as an expense. This lowers the taxable income you must pay the IRS, leaving more cash in your hands.

Depreciation of Capital Improvements

When you add a new roof and install an HVAC system, the property qualifies for depreciation. The good news here is that each improvement is treated differently than the house, so depreciation falls on a shorter timeline. This means you can see the benefits quicker – reduced tax burden and faster ROI.

Equipment and Furniture Depreciation

If you rent out the property already furnished, chances are that you can charge up to 20 percent more for furniture and equipment. The good news is that these can be deducted separately over periods of around 5-7 years. These savings can help you maintain the property in the long run.

1031 Exchange Tax Deferral

Investors can also learn to defer taxes using the 1031 Exchange, which has you investing the proceeds of a sale into a different property. Once the sale is complete, you avoid paying capital gains and depreciation recapture. In the long run, this can help you reinvest and continue growing your portfolio.

Recapturing Depreciation

As an investor, depreciation recapture can be very helpful in saving cash. Taxed at a rate of 25 percent, you can write this tax off the amount of depreciation while you own the property.

For instance, let’s say that you have a $45,000 depreciation. The recapture amount would be calculated based on the formula: 45,000 x 25% = 11,250. The remaining profit (minus the depreciation) will then be taxed at 0%, 15%, or 20%, depending on the tax bracket that you are in.

Proper planning tools like the ones provided by REI Lense can help you keep taxes at a minimum.

Strategies for Managing Real Estate Depreciation

Managing depreciation strategically can benefit you as a real estate investor. Here are a few steps that you can take:

Upgrade Your Property

When you upgrade a property, you don’t only increase its value and make it more appealing for the tenants. You also create more opportunities for depreciation. Since these upgrades often depreciate faster than the property itself, your yearly tax deductions become more significant.

Revalue the Property Regularly

The more you work on your home, the bigger your opportunities for depreciation will be. By re-evaluating, you determine the current worth of the house so that you can find opportunities for improvement. This helps you adjust your depreciation strategy while ensuring compliance with the IRS.

Work with Tax Advisors

Taxes and deductions can be confusing for many people, so working with an accountant is recommended. They can help you track potential improvements, effectively allocate the costs, and navigate through the multitude of tax rules. This enables you to avoid costly mistakes while ensuring you don’t miss out on anything.

Leverage 1031 Exchange

Taxes on depreciation recapture can occasionally be troublesome, which is why leveraging 1031 exchanges can save you money. With this strategy, you virtually defer paying any taxes on the profits by selling the property. After the sale, you can reinvest the money into a property of perhaps even greater value, growing your portfolio without losing capital on upfront taxes.

Take Your Chance Today!

Depreciation in real estate can be a convenient tool for minimizing your tax payments, especially if you plan on holding properties for a longer time. Remember that you should recalculate those amounts regularly since the numbers can change yearly based on numerous factors. Tools like the REI Lense calculator can help you get a more accurate reading and estimate of the numbers.