If you are thinking of buying an investment property in Raleigh, North Carolina or anywhere in the U.S for that matter, a powerful word that you need to know is depreciation. In fact, in the real estate investment space, there are 3 thing you need to know about deprecation.

What is depreciation?

A tax deduction that real estate investors can take for the value of improvements on real estate investment property is called depreciation. According to the IRS Publication 946 (2021), depreciation “… is an allowance for the wear and tear, deterioration, or obsolescence of the property.” One may not depreciate the value of the land since depreciation is only applicable to the value of the improvements on the land. To deprecate a property, you must own it, it must be used in your business or as an income-producing activity, it must have a useable life and that useable life must be greater than 1-year.

How is depreciation calculated?

For illustration only, if an investment property is worth $500,000, and the land is worth $200,000, you can get a tax deduction for $300,000 when you buy the property. Now you cannot take the $300,000 tax deduction all at once in 1-year however you can spread it out over 27.5-years for residential properties.

How can you benefit from depreciation?

In the simplest form, deprecation allows you to take a ‘paper-loss’ when you purchase and/or own real estate rental property. This ‘paper-loss’ shelters part of your rental income from taxes. IMPORTANT: depreciation will eventually need to be paid back when you sell the real estate rental property through ‘depreciation recapture’ (NOTE: there is a way to defer ‘deprecation recapture’ by using a 1031 exchange.

This article has been written by Certified Mortgage Advisor and Raleigh mortgage broker Kevin Martini for informational purposes only and does not constitute legal, tax or financial advice. Please consult with a qualified tax advisor for specific advice pertaining to your situation. For more information on any of these items, please reference IRS Publication 946 and IRS Publication 527.

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