Understanding rental property depreciation is crucial before including real estate in your investment portfolio. Many income property owners get excited about the revenue streams they’ll have coming in, but they might not stop to consider how that property will be valued over its lifespan. That valuation can make or break a real estate investment, because it impacts everything from how much you can charge for rent to your income and property taxes and beyond.
The bad news about rental property depreciation is this: It begins immediately when a property starts being used as a rental and continues throughout its lifespan, much the way a new car depreciates in value the longer you have it. The good news is that rental property depreciation also has upsides.
This quick guide will help you ensure you’re making the most of your rental property’s valuation.
How Rental Property Depreciation Ties to Tax Relief
Investing in rental property can be exciting at the beginning. You’ve purchased something that will bring you additional income, and you’re ready to line up a tenant to see that extra money roll in. The thing people often don’t realize is that the value of the property will dwindle over time, which has a significant impact on your taxes.
You first need to determine how much the value of the property has declined to manage those taxes, which can be done by measuring carrying value against the original cost. You can then lower your taxable income by deducting the cost of purchasing and improving the property over its useful life ― and that includes from both income generated and taxes. This helps landlords maintain their properties’ profitability over time by helping them avoid losses incurred from paying high taxes on properties that have depreciated.
The tax benefits are enormous here, too, since you can deduct the amounts you pay for repairs, maintenance, mortgage, insurance, and other expenses incurred in property management. Knowing the depreciation value will significantly help in keeping these deductions and costs accurate when it comes time to file.
Understanding Real Estate Depreciation
A lot goes into determining how much a rental property has depreciated since you purchased it, but understanding the factors involved in that calculation can go a long way toward making sure you’re maximizing your investment.
Why Calculate Rental Property Depreciation
Calculating rental property depreciation helps in claiming income tax deduction and lowers your overall tax payment for the amount of rent collected in a year. There are several things that go into these calculations, however, including that the initial costs might go up depending on repairs required before you can allow tenants to rent the property. Wear and tear often requires certain items like floors, appliances, and windows to be replaced over time, for example.
Calculating the depreciation value will help you claim these repair and upkeep costs in terms of income tax value. This will save you from incurring extra expenses that exceed the amount you spent purchasing the rental property. Some property owners even hire appraisers to help them determine the actual value of a given property.
What Does Property Depreciation Entail?
Property depreciation encompasses various facets of the property’s fundamental value, including fixtures and fittings that will need to be evaluated before calculating the rental property’s actual depreciation. The cost of repairs may affect the property’s general rental income revenue if not factored into the initial purchase price, for example.
The depreciation value of a house is determined by calculating the house’s value at the rate of 2.5% from the date of construction. Using a depreciation value of 2.5% per year for a property that was constructed in the year 2000 at the price of $200,000 and purchased at $500,000, you can claim up to $5,000 per year in depreciation value.
Knowing this calculation will help you make a profit from rental income, and help you grow net income value of your rental property.
Passive Income Loss Deductions
You might collect huge revenue from your rental property, but you also might end up sinking into tax losses without knowing it. The Internal Revenue Service (IRS) offers myriad guidelines about how property owners can benefit from the passive income generated from a rental property. Passive income is income that requires very little effort to earn or maintain, and it is maximized by understanding your property’s value up front.
The IRS will compensate you for possible losses incurred in running your rental business if you adjust the value of income generated from rental property to slightly below $100,000, for example. This indicates you can claim up to $25,000 dollars in generated passive rental property income against your regular income. It is thus wise to conduct a thorough evaluation of the rental property you intend to acquire before you purchase the property.
Learn More About Rental Property Depreciation
If you are planning to buy an income property in Washington, D.C., Virginia, or Maryland, consider obtaining the assistance of an experienced property management company to help you navigate the process. Depreciation and rental property laws are complicated, but working with a team of experts who are well-versed in their nuances will save you from significant losses in rental income revenue.
If you have any questions about depreciation ― or anything else related to property management ― contact Nomadic Real Estate. Let us provide you with the help you need, resources you can trust, and the expertise you can count on.