When to start depreciation of building
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
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now if you're new here on this channel
we talk about real estate investing
careers and real estate deal analysis
and financial modeling so if you haven't
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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
video
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