An investor can use straight-line depreciation in real estate to claim an annual loss on a property due to predicted wear and tear.
Capital assets for investment purposes must typically be depreciated over a period of years rather than being expensed all at once under the US tax code. For each year a piece of property is used, it depreciates by the same amount under straight-line depreciation. This results in a lower annual tax deduction for a set period of time.
The real estate market has some distinct advantages over the stock market when it comes to investing. As a result of real estate investments being so advantageous, you can invest in them in many ways, including real estate syndications. You might be surprised to know that investors can claim a variety of common tax deductions, as well as other benefits, such as depreciation.
Tax-deductible straight-line depreciation in real estate involves depreciating real property in equal amounts over a specified time period. The depreciation of rental properties such as single-family, rent-ready rental homes, or condominiums falls under specific rules. Rental properties that you plan to fix up and then rent do not fall under this rule.
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Depreciation in the Real Estate Industry
In addition to the tax advantages it offers, real estate funds and properties have benefits that other investments don’t have. Whether you like it or not, owning a long-term investment property will impact your financial situation significantly. Several of these expenses are extremely large and very real, and they affect your bank account frequently.
In addition, you may have phantom expenses which don’t have a direct or immediate impact on your cash flow. In other words, these expenses reduce your taxable income—so you pay less to the Internal Revenue Service (IRS) and keep more of your money each year.
Depreciation is a prime example. In order to account for the natural wear-and-tear of a property’s physical improvements, real estate investors are allowed to deduct depreciation each year. It’s inevitable that things will wear out and need to be replaced eventually, and the depreciation deduction is the government’s way of acknowledging that, even if direct repair or replacement costs aren’t incurred each year.
What is Straight-Line Depreciation?
In a straight-line depreciation method, assets are depreciated uniformly over time until they reach their salvage value. For allocating the cost of a capital asset, straight-line depreciation is the most common and straightforward method.
According to the current tax law, residential investment property depreciates over 27.5 years at equal intervals each year, and commercial properties depreciate over 39 years.
If you are applying depreciation expenses to investment properties, you must follow a number of IRS formulas. Nevertheless, straight-line depreciation is the easiest and most common method for most properties. For a preset number of years, you report the same amount of depreciation as an expense on your tax return.
As discussed above, the number of years varies depending on the type and expected life of the rental property.
How to Calculate Using the Straight-Line Method in Real Estate
Calculating expenses is a challenge. The straight-line basis is one method an accountant can use for the calculation of a real estate’s depreciation expense.
When calculating the straight-line basis, subtract the salvage value from the asset’s purchase price, which is its estimated sell-on value when you decide to resell the asset. The amount is then divided by the number of years the asset is expected to remain useful, otherwise referred to as its useful life.
Formula: Straight Line Basis = purchase price – scrap value / useful life
Pros and Cons of Straight Line Depreciation
Accounting professionals prefer the straight-line method because it is simple to use, produces fewer errors over the asset’s life cycle, and maintains the same expenses all the time. As opposed to more complex methodologies, such as double declining balance, straight lines are simple and calculate depreciation using just three variables at a time.
Along with its simplicity, the straight-line basis has a lot of disadvantages as well. Utilizing this method has the obvious disadvantage of relying on guesswork for useful life calculations. As an example, an asset could potentially become obsolete sooner than expected due to technological advancements.
Furthermore, the straight-line basis does not account for the likely accelerated loss of an asset’s value over time, nor does it take into account the rise in maintenance costs as the asset ages.
Enjoy Depreciation Benefits with Real Estate Investment
Rentable properties, commercial real estate funds, and capital improvements to assets can all be depreciated with the straight-line method. Utilizing and learning this simple formula can reduce tax obligations, improve accounting methods, and provide a better understanding of current business value.
To take advantage of these tax breaks, you should ensure that you structure investments in accordance with your financial plan.
By investing with us, investors can reduce their risks and gain more stability. To ensure long-term stability for real estate funds, our team carefully selects investment opportunities from a variety of property types.
For more information on straight-line method real estate, please email us at info@saintinvestment.com or call us at 949-881-7128 at Saint Investment Group today!
Frequently Asked Questions:
For a specific amount of time, the IRS permits property proprietors to write off a part of the cost of the asset each year when filing their taxes. For domestic renting properties, the depreciation term is 27.5 years, while for nonresidential properties it’s 39 years.
The formula for calculating straight line depreciation for real estate is: (Property Cost – Salvage Value) / Useful Life
Other methods of depreciation, such as accelerated depreciation and MACRS, allow for larger deductions in the early years of ownership. Straight line depreciation, on the other hand, provides a steady, predictable deduction each year.
No, only property used for commercial or leasing reasons qualifies for a depreciation exemption.
You might have to pay back some or all of the depreciation you declared as a gain on your taxes when you sell the property. The property’s selling price and the amount of depreciation declared will determine the amount of recaptured depreciation.
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President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.
