TAX BENEFITS FOR REAL ESTATE INVESTORS – COMPONENTIZING DEPRECIATION
January 30, 2013 By Larry Arth
Do not fall to sleep just yet! Granted we know that tax benefits for real estate investors sounds like a boring topic. However, it is a topic (when understood) that can benefit you greatly as an real estate investor.
Question for you to ask your tax preparer: Are they utilizing this strategy or do they even know what it is? Just last year I was attending an investment seminar for accountants (better than half of the room was filled with accountants). Less than half of the accountants in that room said that they were familiar with utilizing this strategy. (NOTE: I am certainly not a tax professional and am not aiming to offer any tax advice, I simply would like to bring some recent awareness to you so that you to may be able to maximize your tax benefits)
First of all, what is componentizing depreciation?
Let’s break it down:
Residential real estate can be depreciated over 27.5 years and commercial real estate can be depreciated over 39 years. Let’s stick with residential for now. Deductions are considered to be one of the 5 wealth building principals and, depending on your personal circumstances, can be a huge hidden benefit to you.
Depreciation is when (for tax purposes) you are allowed to devalue your investment property over the course of time (residential 27.5 Years). Simply stated, for each year you can deduct 1/27.5% (3.63%) of the value of your property as a loss on your income tax statement. Example: You have a $100,000 property x 3.63 = $3,630. This is a $3,630 deduction for you. But wait, here is where understanding componentizing depreciation gets interesting!
The building itself can be depreciated over 27.5 years. (3.63%) – this is pretty common knowledge. The land may not be depreciated (not everyone understands this). The personal property, things like a/c, appliances, flooring, etc. have accelerated depreciation over 5 years or 20% per year.
The land improvements, things like fences, driveways, shrubbery, etc. can be depreciated over 15 years. (6.6%) (THIS is where we lost better than half of the accountants in the room).
It is possible to save even more by being treated as a “real estate professional”. Your tax advisor can clue you into these rules and, if they apply to you, more savings will be coming your way. If you invest in real estate but do not qualify as a “real estate professional”, you are limited to $25,000 realty investment property loss deduction against your ordinary taxable income. This is called the passive loss restriction. This “loss” includes the paper loss created by depreciation.
If you are a treated (for tax purposes) as a “real estate professional” who meets certain time requirements who “materially participates” in managing your investment property, who spends minimum required number of hours per year on these real estate tasks, then you are allowed almost unlimited income tax-deductions from your investment property.
As an investor I have learned to make sure I have great accountants who understand these tax strategies designed to save the big bucks. You too may want to ask your tax person about these benefits. But no, I am not an accountant and laws may change state to state so ask your tax preparer how this may affect you.
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