If you're investing in real estate for the long term, there's one word you need to understand: depreciation.
Depreciation is an important part of owning investment property. It can provide valuable tax benefits while also reminding investors of something that is easy to overlook—the fact that buildings require ongoing investment and maintenance over time.
What Is Depreciation?
In simple terms, depreciation allows property owners to account for the cost of a building over its useful life for tax purposes.
For many residential rental properties, the building is generally depreciated over 27.5 years under current federal tax rules. Commercial real property generally uses a 39-year recovery period.
It's important to understand that you are not simply depreciating the entire purchase price of a property. Land generally cannot be depreciated, so the value of the land and the building need to be considered separately.
Because depreciation is a non-cash expense, it can reduce taxable rental income even though you aren't writing a check for that expense each year.
That can make depreciation an important part of a real estate investor's overall tax strategy.
Depreciation Isn't Just a Number on Paper
While depreciation can provide a tax benefit, there is another side of the concept that real estate investors should keep in mind.
Buildings wear out.
Over the years, roofs need to be replaced. Furnaces eventually need to be upgraded. Flooring wears down. Kitchens and bathrooms require updates. Exterior systems need maintenance.
Even when a property is well cared for, it will require capital investment over time.
In that sense, depreciation is more than a tax concept. It is also a reminder that your property will require ongoing investment to maintain its condition and value.
Plan for the Long Term
One of the biggest mistakes a property owner can make is looking only at today's cash flow.
If you're collecting rent and the property is producing positive cash flow, it can be tempting to view all of that money as available income. But experienced investors understand that some of that cash flow needs to be considered alongside future repairs, replacements and improvements.
Planning for those expenses can help prevent a major repair from becoming an unexpected financial burden.
The goal isn't simply to own a property. It's to maintain and manage that property effectively over the long term.
Depreciation and Your Wealth-Building Strategy
For real estate investors, depreciation can be one piece of a larger wealth-building strategy.
Rental income, property appreciation, loan paydown and potential tax benefits can all play a role in the long-term economics of an investment property. How those pieces apply to an individual investor depends on their property, finances and tax situation.
That's why it's important to work with qualified professionals who can help you understand the numbers and make informed decisions.
At Redwood Prime Realty, we want our investors and clients to understand both the value and the real cost of owning real estate.
Depreciation can work in your favor from a tax perspective, but it also reminds us that every property requires ongoing care and capital over time.
If you're investing in real estate for the long term, don't forget this important word: depreciation.
Tax laws and individual circumstances vary. This article is for general educational purposes and is not tax advice. Consult your tax professional regarding how depreciation applies to your specific situation.
