Depreciation Benefit of a Real Estate Investment

The Depreciation benefit is perhaps the best of the four benefits. A process called cost segregation assigns property assets and improvements to various categories each subject to different depreciation schedules. This process allows the owner of rental properties or other investment properties to maximize the tax deductions permissible by law. The four categories and their depreciation time frames are:

  • Land
  • Buildings: 27.5 years for residential investments or 39 years for commercial investments
  • Personal Property: 5 years
  • Land Improvements: 15 years

These categories allow the buyer of a investment property to write off deductions faster and therefore have better cash flow. Let us look at our example. The property cost $165,000. Looking at the tax record for the duplex, the land has a value of $25,000. You can not depreciate the land because it will always be there. However, you can depreciate the building ($165,000 less $25,000 or $140,000).

  • Land: $25,000
  • Buildings: $140,000

Only taking depreciation on the building will give you a depreciation of $140,000 x 3.48 (percentage factor for first year ownership starting in January) = $4872. Now lets look what happens if you use cost segregation. There are 2 refrigerators, 2 stoves, 2 vent hoods, 800 sq ft of carpet, 8 window blinds, 200 feet of 4 ft chain link fence. The fence can be considered as a land improvement and therefore subject to a 15 year depreciation schedule. Its cost is $1000. The other items are Personal Property and are subject to a 5 year depreciation schedule. Their cost is $3400. Multiplying each category value by the appropriate first year depreciation factor yields the following:

  • Land: $25,000: DEPRECIATION = $0
  • Buildings: $135,600: DEPRECIATION: 135,600 X 3.48% = $4,719
  • Personal Property: $3400: DEPRECIATION: 3,400 X 20% = $680
  • Land Improvements: $1000: DEPRECIATION: 1,000 X 5% = $50
  • Total Depreciation: $4,719 + $680 + $50 = $5,450

That’s $578 more in depreciation benefits than if you were not to use cost segregation. Place these values into your worksheet so that it looks like this. The values in the investment property calculator worksheet tell you two things about the power of the Depreciation Benefit: (1) Even though you show a positive cash flow of $987 and a positive reduction in principal of $1,341, there is a negative taxable income value of $3,123 which means you show a loss on your tax returns and; (2) Depending on your tax bracket (35% in our example), this means there is a tax savings of $1,093.

Don’t forget the Appreciation Benefit after the all powerful Depreciation Benefit.