Real Estate Articles » Taxes

The Truth About Depreciation

By: Niman S.
Submitted: 02:21PM on Monday 18 August 2008

As a rental property owner, there are no tax benefits to making principal payments for your property – you only get to right off the interest. As a result, many people get taxed on their income from rental properties, and if you are like me, you don’t want to get taxed on the additional revenue that your rent brings you. One good thing about owning rental property however is that you can claim a tax loss even though you are making a profit. This is possible through depreciation.

By maximizing depreciation deductions, you minimize taxable liability and save money on taxes. Since you cannot immediately write-off the purchase cost of investment property, you must deduct the acquisition cost over the life of the property using depreciation.

Most rental owners are able to turn profits after collecting rent and paying rental expenses, so depreciation deductions can be used to turn their profits into tax losses. That's why rental property is considered such a good tax shelter - because you can report a loss even though you are making a profit.

For example, you collect $12k rent for the year and paid $8k in rental expenses like mortgage interest and property tax. If you took no depreciation deduction, you would have to claim $4k in rental income on top of your regular income... but after a $6k depreciation deduction (typical for property worth $165k), you will claim a $2k loss while still making a $4k profit. So the depreciation allows you to avoid taxes on the additional income ($4K) that you made, and it also allows you to take a loss ($2k) against your other income and pay less taxes against what you would have owed without the rental property.

I hope this explanation was easy to understand. Depreciation is a simple concept but can easily turn into a difficult topic. For example, depreciation may be recaptured at a rate of 25%. Also, there are passive activity rules that limit the amount of loss you can claim, and then again, there are exceptions to that rule that allow you to take unlimited losses.

Be sure to consult with a tax advisor to consider your specific circumstances.