Depreciation – A Financial Advantage for Residential Rental Property Owners
Before we begin I’d like to point out that I’m not a tax expert and highly suggest that you consult with a professional in this field for precise and accurate details. An accountant specializing in real estate investing is a must. Tax benefits is one of the pros of owning property. While you don’t have to pay taxes on income from rental properties, it doesn’t mean that you can just simply go by just not filing or paying anything at all. To make your income tax-free, these are some of the things that you have to do and in order to do right, work with a tax professional.
Depreciation – Why does it matter?
It’s legal and acceptable to not pay taxes on rental property income. You can also claim “losses” on income, the “loss” is placed towards your other life income, that way you end up making more on top of not having to pay taxes.
Basically, it works like this: The deductions that you are able to write-off on a rental property usually exceeds the amount you get from rent payments. You can legally write off as much or more than what you received on the property. Therefore, nothing left to pay tax.
As to how write-offs possibly equate more than what you bring in, it’s because of depreciation.
This is a term used by the IRS for an income tax deduction allowing taxpayers to recover expenses on a property. It’s an annual allowance for the deterioration of the property.
The IRS lets you write off what they find to be valid for depreciation based on the value of a property (excluding the land).
Here’s an Example
Let’s say the value of the property is $200,000 divided by 27.5 (IRS uses a 27.5 year straight-line schedule. Then the amount left is what you can write-off) equates to $7,272.72 per year. This allows you to write off over $7,000 per year which is what they call a phantom loss because you didn’t lose any actual money.
Adding the $7000 per year to the mortgage interest, expenses (tax, insurance, maintenance), HOA, and Management fees. All of these combined is what you’ll be writing off against the income generated by the property. If these equate to the amount generated by the property, you don’t pay taxes. If it’s more, you can take the loss against other sources of income. This may lower your taxes more or even place you at a lower tax bracket.
As I said earlier, it is paramount to find an accountant that specializes in real estate investing. There are various scenarios and contingencies that must be taken into consideration to apply the tax deduction accordingly.