Importance of Rental Property Depreciation

A common mistake among real estate investors (I am guilty of this too, when I first started investing) is that they often do not deduct depreciation on their investment properties when doing their taxes. The government allows you to take a depreciation deduction each year on your investment properties. There is a schedule that tells you how much your property has "gone down" in value each year. The idea is that property gradually degrades over time, so its value also decreases over time. In general this is true of furniture, television, vehicles, etc. But the same cannot be said for real estate. Real estate has a "perceived" value that usually gradually increases over time. But good old Uncle Sam has provided this nice perk for real estate investors. Even though we know property that is bought right and maintained can drastically increase in value, the government allows us to take a yearly tax deduction for a reduction in the property value. There are tables provided by the IRS that calculate how much the depreciation will be for your property.

There is a specific procedure that must be followed to properly depreciate your real estate as well as the personal property within the property. You will need to consult your tax professional for those details :).

But back to the mistake most investors make .... the problem with not claiming your depreciation every year is that when you sell the property, you must recapture that past depreciation, whether you took it or not. The IRS will assume that you took it anyway, so you will end up paying taxes on the recaptured depreciation even if there is nothing to recapture. If you have missed this important step, you can catch up by filing a Form 3115 and attaching a statement to accelerate your past depreciation.

In general, depreciation is pretty much like reaping gains from the investment property when you own it and then paying it back after you sell the property. Depreciation is useful for getting a "net" cashflow from investment properties while you own them through increased tax breaks.

Once again consult your tax professional to sort out the details and find the solution that is best for you.