Real Estate Depreciation Explained

hey guys this is Justin from braking to

crüe calm and in today's video we're

going to talk about depreciation in real

estate so if you're trying to understand

how depreciation actually works in real

estate investing and what the details of

depreciation are definitely stick around

for this video


now if you're new here on this channel

we talk about real estate investing

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video now real estate is one of the most

tax advantaged investment vehicles out

there and that is for good reason so

governments tend to structure tax codes

to incentivize certain behaviors and

private real estate ownership is one of

those behaviors that they want to

incentivize and appreciation is a huge

part of that and allows investors to

take advantage of some serious tax

benefits in real estate investing so by

the end of this video you'll know what

depreciation is what the different kinds

are and how you can apply it to your

next real estate deal so let's start by

first defining what depreciation

actually is so depreciation is defined

by the IRS as a capital expense that is

the mechanism for recovering your costs

in an income producing property and must

be taken over the expected life of the

property now the way this works in

practice is sometimes referred to as a

phantom expense meaning that even though

you won't actually pay cash out of

pocket in order to pay for this expense

at the end of the year you're going to

be able to deduct depreciation expense

from your total taxable income now the

way this is structured for many real

estate investors especially if they put

debt on the property oftentimes

depreciation expense can shield any sort

of taxable income that you may otherwise

have generated from a real estate

investment so with that all said what

are the details of depreciation and how

does this actually work

well the first thing to know as a real

estate investor is you're only able to

depreciate the improvements on the land

of the property that you own so over

time a building and its contents may

depreciate there may be wear and tear on

that building and its contents and the

improvements on the land but the land

isn't going to depreciate over time and

oftentimes that land is actually going

to appreciate so you can only take

depreciation expense based on the value

allocated to the improvements on that

land so now that you know what to

depreciate how do you know the

appropriate amount that you need to

depreciate each and every year well for

commercial real estate so anything out

side of multifamily properties the

general recovery period is 39 years so

essentially what this means is you'll

take 139th

or about 2.6 percent of the value of the

improvements and add that as a

depreciation expense on your property

every year now for residential rental

properties so anything from 1 to 4 units

and also 5 and more units that's going

to be depreciated over a twenty seven

and a half year schedule so since there

may often be more wear and tear on a

residential property you're able to

depreciate about 3.6 percent of the

improvements on that land every year now

all of this assumes that you use

straight-line depreciation which applies

that same depreciation expense every

single year but there are two main ways

that this is going to be modified and

the first way is through a cost

segregation analysis so when you buy a

piece of income-producing property

you're not just purchasing the building

and the land but you're also buying

improvements to the land and contents

within that building so as far as

improvements to the land this may be

things like fencing carports lighting or

other equipment that may be on that land

and inside the building you might be

buying things like appliances window

coverings floor coverings and even

things like the wiring of the building

so while it may take thirty nine or

twenty seven and a half years to

depreciate the actual building structure

land improvements can be depreciated

over a shorter time window of 15 years

and building contents can generally be

depreciated over a five to seven year

time frame now what this means for real

estate investors is that they're able to

benefit from a much bigger depreciation

deduction in the first few years of

ownership and oftentimes if you only

plan to own a property for five or seven

years this can be a huge tax benefit for

a real estate investor now to do this

you'll need to do what's called a cost

segregation study and as part of that

you'll need to hire a team of CPAs and

engineers but oftentimes the tax savings

from doing this can offset the cost of

this completely now the second thing

that can change this is the new bonus

depreciation rule that was enacted

through the tax cuts and Jobs Act of

2017 and what this does is it

essentially allows investors to

depreciate up to 100 percent of

qualifying real property expenditures in

the first

year of ownership now these qualifying

real property expenditures include

anything with a useful life of under 20

years so those land improvements that we

talked about with a 15 year lifespan and

the building contents that we talked

about with a 5 to 7 year lifespan can

now be depreciated 100% in that first

year now if this sounds too good to be

true it is and here's why when you go to

sell a property you're going to have to

pay what's called depreciation recapture

tax and the current tax rate for

depreciation recapture is 25% meaning

that all the depreciation that you took

during your entire ownership period

you'll have to pay 25% of that back in

taxes when you go to sell the deal that

said you may be able to defer this

through a 1031 exchange but it's still

something to be aware of when you're

taking depreciation expenses to make

sure that you know what you're getting

yourself into

on the back end so at the end of the day

depreciation can be a huge tax benefit

for real estate investors and with the

right team of accountants and engineers

on your side depreciation can be a huge

benefit to you as a real estate investor

now if you want to learn more about how

depreciation is actually going to affect

your real estate cash flows check out my

course commercial real estate investing

101 we'll go over all about after-tax

cash flow analysis and how to actually

run that in a commercial real estate

deal and if you want to go deeper into

all of this and get access to all of my

courses all of my models and some

additional one-on-one support make sure

to check out break into CRA Academy and

I'll link that in the description as

well so thanks so much for watching if

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find this helpful thanks so much for

watching and I'll see you in the next