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Owning rental property can be a profitable investment in the long run, however it does come with a plethora of financial considerations, which can be a real burden. One of the most important yet often misunderstood and neglected concepts is depreciation. No matter if you are a first-time investor or a seasoned property owner, understanding rental property depreciation can help you reduce your taxable income and immensely improve your cash flow, which is certainly your end goal, right? Therefore, let’s dive into what rental property depreciation is, what exactly does it entail, and how you can use it to your advantage.
Depreciation 101
Put plainly, depreciation represents the process of spreading the cost of an asset over its useful life. When it comes to rental properties, depreciation allows property owners to deduct a portion of the property’s cost each year for tax purposes and in that way save a lot of money, stress and energy. The entire concept of depreciation is based on the idea that properties lose value over time due to wear and tear, aging, and other factors.
What is Property Depreciation?
Rental property depreciation can easily be defined as an income tax deduction various real estate investors can utilize to their favor to help justify the earnings they make from their rental property. Even though depreciation isn’t a real out-of-pocket, as a homeowner, you can collect depreciation for numerous items. In the real estate world, depreciation is more like an accounting method that can help you reduce your taxable income and help you with tax savings significantly. Depreciation tends to begin when the rental property is put into service in order to produce income and usually stops when the user has completely recovered their cost.
How Does Rental Property Depreciation Work?
Rental property depreciation is a form of non-cash deduction. Imagine that you want to rent a house or a flat and you want to invest in refurbishing the exterior and perhaps painting the property. You can always consult with a rental property depreciation professional to see how to claim tax deduction depending on the type of repair or maintenance you opt to do on the property. Nowadays, you can claim labour costs, maintenance, and many more taxes so as to lower the amount of taxes you owe. No matter if you are hiring a professional painter or opting for some DIY work, rental property depreciation will help you get tax return, as long as you have a professional by your side to guide you through the process.
How Depreciation Affects Your Taxes
Depreciation can have a direct and fruitful impact on your tax bill. By reducing your taxable income, you may owe less in taxes which is a very satisfactory option. Here is an example: if your rental income is around $20,000 in a given year and your depreciation deduction is $10,000, you will only be taxed on $10,000 of rental income. This reduction in taxable income can result in significant tax savings, especially over the long term. However, there are a few considerations to bear in mind:
- Recapture of Depreciation: When you sell the property, the IRS requires you to “recapture” the depreciation deductions you’ve taken over the years. This means you may need to pay taxes on the amount of depreciation you claimed at a rate of 25%. For instance, if you deducted $100,000 in depreciation and later sell the property, you might owe taxes on that amount when you sell.
- Passive Activity Loss Rules: Depreciation may also help you offset other passive income, such as from other rental properties. However, if your rental activity is considered a “passive activity” under IRS rules, you might be limited in how much depreciation you can claim in any given year.
Final Thoughts
Rental property depreciation is a powerful concept that can help people save money on taxes. By comprehending what depreciation, how it functions, and how to estimate it, you can reduce your taxable income and keep more money in your pocket. If you’re unsure how depreciation applies to your rental properties, it’s a good idea to consult with a tax professional, a lawyer, or accountant. They can help ensure you’re maximizing your deductions while complying with all vital legal guidelines, allowing you to make the most of your real estate investments.
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