Investing in real estate has some distinctive advantages over investing in the stock market. There are some ordinary tax deductions available to investors, but there are also other benefits, like depreciation, that you may not know about. Straight-line depreciation is the depreciation of real property in equal amounts over a designated lifespan of the property as allowed for tax purposes.
A Simple Example of Straight-Line Depreciation
If you can depreciate a certain property costing $180,000 using a tax depreciation period of 27.5 years, you would divide $180,000 by 27.5 to get an equal straight-line amount of $6,545 in depreciation each year. This is your annual depreciation deduction, and you didn’t spend any additional costs to obtain it. It’s simply yours to invest in, in the first place.
How to Calculate Straight-Line Depreciation in Real Estate
Of course, there are other rules and figures you need to include in the calculation. In fact, you should start with the “basis” in the property, not necessarily the exact purchase price. There might be some variations. You can reach your basis by adding your closing costs, such as legal fees, any transfer taxes, title insurance, property appraisals, and recording fees.
Due Diligence and Correct Purchasing
You don’t want to consider this potential depreciation when evaluating a rental home for investment. You can think about how great depreciation is when you do your final calculations, but you want to focus just on the essentials and concentrate on cash flow when you start in on the deal.
Deductions of Expenses
Your expenses can also be deducted from your income for tax purposes. You can also deduct mortgage interest, though it’s not considered an operating expense.
Depreciation Recapture
The IRS will recapture some of your tax savings when you sell the property. You will have to report the difference between your basis and the sale price in the year you sell it as income.
Growth Through 1031 Exchange
You can only use a 1031 exchange if you decide to grow your portfolio by selling properties for a profit and immediately reinvesting those funds into new properties.
Please note that you should consult a CPA due to the complexity of the procedure and the strictness of the rules. The investor typically does not play an active role in that. A third party must step in to receive the sale proceeds and distribute the funds to purchase the new property.
You won’t have to pay capital gains tax when you sell the property in the year it’s sold if done correctly. You can defer capital gains tax until you eventually sell the property and fail to reinvest the sale proceeds into another property.
Source: https://www.thebalancemoney.com/straight-line-depreciation-of-real-property-2867364
Leave a Reply