Don’t Forget This Powerful Real Estate Tax Strategy | USTaxAid

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Don’t Forget This Powerful Real Estate Tax Strategy

Written by Diane Kennedy, CPA on July 10, 2021

The first Wednesday of each month of Wednesday Coaching is about real estate. The 7/7/2021 class talked about depreciation strategies for real estate investors.

There are a few tax strategies that I talk about that I can just count on getting push back from some. One of those things is depreciation. There is so much bad information about there!

What is Depreciation Really?

The theory with depreciation is that, over time, some assets go down in value. Think of a car. If you buy it new, the value goes down the minute you drive it off the lot. That’s depreciation. In the case of real estate, it does depreciate over time. You have to repair it. You have update it. The depreciation, though, is usually far outweighed by general appreciation.

The depreciation is a tax deduction. But in many ways, depreciation doesn’t really exist with real estate. You get a tax deduction because something goes down in value, but in real estate, it’s more likely to go up in value. Plus, it’s one of the few deductions you can take on your tax return that don’t cost you any actual cash.

If you buy a new computer for your business or real estate, you can write it off. If you buy office supplies for your business or real estate, you can write them off. It took cash (or credit) to buy the items, but at least you got the write off.

Depreciation didn’t cost you anything and in a very real sense, doesn’t even exist when it comes to real estate. It goes up in value, but for tax purposes, we get to pretend it doesn’t appreciate. 

Depreciation Calculation Tricks and Traps for Real Estate Investors

Now, let’s look at how depreciation works for a real estate investor. When you buy a property, there are several components. You need to apportion the basis into these components. Here’s how it might work in real life for you. 

You buy a single-family residence (SFR) rental. Let’s say it’s $150,000. In reality, though, the value will likely include closing costs. Some will be immediately expensed. Some are amortized over a time period. And some are added into the basis. The details of breaking down the closing statements when you buy is just one of the many items included in “Easy Accounting for Real Estate Investors.” This is just part of Real Estate Accountant in a Box, which will soon be available at, when our new website launches. 

Depreciation Mistake #1

Unfortunately, some people have been told that there is only one way to take depreciation for your real estate. It’s always 27.5 years or 39 years. That is WRONG!

First of all, you need to reduce your basis by the underlying land value. Land is not depreciable, but I still see people trying to take a depreciation deduction for it. That’s just flat wrong.

Land is not depreciable. You need to allocate some of the basis to land. That’s the first allocation that needs to be made. What is the value of the land, without improvements?

In the example of the $150,000 property, let’s say that a lot in that area would sell for $40,000. That means that $40,000 of the $150,000 needs to be allocated to non-depreciable land. You’re left with $110,000 to depreciate.

Depreciation Mistake #2

If you get this far with the allocation (allocating the land), you then need to decide how you’re going to depreciate the $110,000.

Most people just take the easy, no strategy method, of depreciating the rest over 27.5 years (residential) or 39 years (non-residential.)

That’s the second mistake. You’re missing the benefit of a phantom expense strategy.

Depreciation can be stopped (you don’t take any depreciation in the current year). It can be slowed (taking it all at the longer period.) You can accelerate it (using a cost segregation study.) You can catch it up (use a cost segregation study after the fact.)

If they get the land valuation right then they just take everything else and depreciate it over 27.5 years or 39 years. Nope.

Well, I should say it’s an option, but only one option. There are a lot of different options when it comes to depreciation for your real estate. 

First, though, you need to have a strategy. Sure, you can learn HOW to do something, but is it the right thing for you and is now the right time? That’s where the true value is. Knowing what to do and when. 

Things to Consider With Your Depreciation Strategy 

Because we have so many tax strategy options when it comes to depreciation, we need to look for what is the best fit for you.

Some of the things to consider: 

  • What is your AGI? 
  • Do you have an overall net income or net loss from your passive real estate? 
  • After deducting direct expenses and indirect expenses, do you have taxable income from your real estate?
  • Do you plan to sell your property soon and thus don’t want to have to recapture the depreciation it at a higher tax rate?
  • Are you currently (or do you plan to be) a real estate professional? 
  • If you’re married, filing jointly, is your spouse a real estate professional? 

Once you have your basic real estate investment tax strategy facts together, you need to consider what your future with real estate will be. Are you using a Five F and C strategy that will give you five free and clear houses in 10 years? Or maybe you’d rather maximize the number of properties you have to hit critical mass as soon as possible? That may mean dumping real estate properties that don’t give you the numbers you need. Or maybe it means flipping properties.

And what is your exit strategy from real estate?

All of that matters when it comes to determining your depreciation tax strategy. YOUR strategy. 

Another Depreciation Tax Strategy Tool

Tax law keeps changing. What worked before might not work now. There were some pretty significant changes in 2009, 2011, 2014 and of course, big changes in 2018 with the Trump Tax Plan. Pres Biden is now talking about another round of big changes.

It’s never been more important to keep up with the tax law changes. 

Unless, that is, you don’t mind paying too much in taxes.

There are several ways we can help you. You can get a private consultation

with me to create a step-by-step strategy plan. You can join Wednesday Coaching

and learn about strategies, plus ask questions. Not sure which is best? Contact Us!  

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