Depreciation of residential real estate is the process of gradually reducing an asset’s value until it becomes obsolete. It enables investors to look for tax savings. Accounting for depreciation involves no actual cash flow.
Residential investment properties serve a very different purpose and function than commercial properties. Commercial property is by definition meant for business purposes, while an investment residential property is one that is leased to tenants through a lease agreement specifying move-in dates over an agreed-upon period.
Investment residential properties include single-family homes, duplexes, or multi-family apartment buildings. Cash flow can be greatly improved if you claim depreciation deductions on residential investment properties.
Following interest, rental real estate depreciation is the second most common tax deduction for property investors.
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Investing in Residential Properties
Investment in residential real estate has increased due to the lucrative nature of the sector. A residential real estate investor is primarily interested in managing the property, increasing the cash flow, and maximizing its value. As dictated by the current US Tax Code, the depreciation of commercial properties is over 39 years. However, residential properties have depreciated for over 27.5 years.
Despite what it might sound like, property depreciation is actually a useful tool for rental property owners to reduce taxes and is something that is often overlooked. The following provides more information about the depreciation of residential real estate.
What is Depreciation in Real Estate?
In simpler terms, the depreciation system is a reduction in value caused by wear and tear as the property ages. In the same way that a car depreciates, once it leaves the lot, a building depreciates when it is placed in use or rented. The same applies to any building, regardless of whether it is a commercial or a residential one.
In most residential rental properties, the depreciation rate is estimated to be 3.64% every year for 27.5 years, depending on the type of property. Depreciation does not apply to the land itself, since it does not wear out the same way as tangible property. However, you can depreciate appliances and carpets, even if they are not part of the actual building.
Although depreciation of residential real estate may seem less-than-ideal, it can actually be used to write off the property as well as any improvements you make to it as tax deductions. As a result, you will be able to save more money in the process.
What are the Tax Implications of Depreciation?
When investors file their annual taxes, depreciation can be included in their expenses. Depending on the tax bracket in which the investor falls, their tax liability will be reduced. The amount of the deduction will be determined by that percentage.
Investors benefit from depreciation by spreading the cost of a property over several years and claiming deductions during each of the years they hold on to their property. Rather than a building wealth strategy, it offsets investment losses.
What Can You Depreciate?
Tax advantages require you to have already invested in the rental property. A rental property can be depreciated not only for its initial costs but also for any improvements made to it. Improvements include anything that enhances the value or usefulness of the property, makes it more suitable for a new purpose or restores its original condition.
Depreciable assets are components that add value to the rental properties and any associated costs when managing them. The laptop you use to track your rental business data or home improvements that add value to your property are all acceptable expenses. At the minimum, the deductibles must have a shelf life of one year and decrease in value over time.
Those are fairly broad definitions, which give you a lot of flexibility when it comes to depreciating your property. Rental property depreciation includes the following improvements:
- Constructing a garage, storage, or other structure
- Adding new utilities to the property
- Replacing the roof
- Installing carpeting
- Adding ramps and other accessibility features
As routine repairs and maintenance are not considered improvements, they are not depreciable, but you can still deduct maintenance costs in the year they are incurred.
Considering a Residential Real Estate Investment?
It is important to understand rental real estate depreciation so that you can make the right long-term choices for your investment. Want to take advantage of depreciation and buy residential real estate? We are here to help.
Our investment specialists leverage extensive experience to bring you the best real estate advice—regardless of whether you’re looking for a specific property, or if you’re just getting started on real estate funds.
To get started, contact us at 949-881-7128 at Saint Investment Group today!
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.