The Things That You Didn't Know About Depreciation of Real Estate

New investors believe that depreciation of real estate means a drastic loss in earned money. These are just a few of the things that you didn't know about the process and why its important that you include depreciation of real estate and why its so beneficial for investors.

When real estate investors hear the term depreciation of real estate, their reaction is almost scary. Property investors think that by the reduction in value of their property, which they are going to lose out on a lot of generated income. Due to this fear, investors will try every tactic to avoid the depreciation of their investment property. What is depreciation of real estate? It is a term used to describe an annual tax deduction toward the wear and tear for commercial and investment properties. The deduction will increase over time as property loses its value. This particular deduction is called depreciation of real estate.

Why are so many real estate investors afraid of claiming their properties depreciation on their income tax? Though a depreciation of real estate tax lowers the investor’s net income, the taxes of the capital gain of the investor by selling the commercial property to another party can go up. This tax was set at 25% for all recapture of depreciation of real estate plus a capital gain tax of 15% not including federal and state taxes. This could leave a taxpayer paying in sums of 30% or more in to the IRS if they sell their investment property. The annual tax is dependent on the type of property you own where you would take out 3.64% for rental housing for a 27 1/2 year life and 2.55% on commercial and industrial property on a 39 year life span of the investment itself.

There are two types of depreciation of real estate that is straight line and accelerated. Each is different on how you are taxed in which a straight line uses the same percentage per annum while the accelerated method is taxed on as ordinary income. What exactly is an accelerated and a straight line depreciation? Below explains what they are and some examples of how both straight line and accelerated depreciation works:

Accelerated depreciation is any method of depreciation that is used for accounting or income tax purposes that allow a greater deduction in the earlier years of life on an asset. Here is an example of the use of accelerated depreciation: A corporation has invested in an apartment building for $100,000 that is projected to run for 27.5 years. Utilizing the easiest form of depreciation, the corporation may allow $3,640 of the cost of the property to its expenditures each year for 27.5 years, until the $100,000 in capital expense has been met. Under accelerated depreciation, the corporation may be allowed $7,280 per annum for 13.75 years for the cost of the rental property.

Straight line depreciation is the easiest and the most used form or depreciation, where a corporation in which the salvage value of an asset is evaluated at the end of the period during which its used to generate revenue and will use a portion as an expense of the original cost in equal payments during that period. An example would be an investment broker purchased a three bedroom house for $60,000 and its expected to last for 27.5 years. Once the real estate broker begins to rent the property out, he will pay in $2,184 each year as an expense over the course of 27.5 years until it reaches the capital expense of $60,000.

With these in mind, a depreciation of real estate is beneficial to investors everywhere. Not only does this create a security blanket during tax time, but this will assist you in which method better suits your needs during tax season.