Tax Benefits

14 Replies

What exactly are the tax benefits from buying a rental property? How much money should I expect in tax benefits/tax refund from my investment property? Is it a percentage of the interest rate paid? Are there any others? I am trying to get real world numbers. Thanks in advance!

Originally posted by @Felipe Ocampo:

What exactly are the tax benefits from buying a rental property? How much money should I expect in tax benefits/tax refund from my investment property? Is it a percentage of the interest rate paid? Are there any others? I am trying to get real world numbers. Thanks in advance!

 To be clear, the tax benefits are in offsetting your income, not in a tax rebate/refund per se.  The primary deductions you'll get are depreciation of the property as well as the mortgage interest you pay.  Remember, these are deductions, not credits, so they only serve to offset the income that you make - income from both the real estate investment activity as well as your primary income/"day job"

Yep, @Matthew Saskin nailed it.  There is a new $600 rule on repairs now too I heard.

@Matthew Saskin and @Jerry W. Thank you for your responses. So basically you don't get as much with a tax deduction as you would with a tax credit. Do you get a tax deduction for the full amount of the mortgage interest that you pay or just a percentage? Also, how are the deductions based on depreciation calculated? Are they a percentage of the property value? Are these linear or exponential depending on the age of the property?

@Felipe Ocampo

All great questions. It will be in your best benefit to connect with a real estate savvy CPA for a consultation. This way, answers to your questions can be tailored to your specific situation. 

In general - you can take a deduction for the full amount of mortgage interest, property taxes, insurance, advertising, legal and professional fees, bank fees, property management and utilities. 

Depending on what a repair expense is in relation to depends on whether or not you are allowed to deduct the repair costs. For further reading, please check out my blog posts and previous posts on the IRS Final Tangible Property Regs. They will have plenty of information about repairs. 

Depreciation is calculated based on the improvement value of the property as you cannot depreciate land. To find the improvement value, you must find the improvement ratio. This can be done a number of ways. If you buy a property for $100k with a 90% improvement ratio, your cost basis for depreciation is $90k. Additionally, capital improvement increase your cost basis and annual depreciation. 

Think of depreciation more as an interest free loan as you will have to pay "depreciation recapture" upon the disposition of your property, currently at a flat 25% rate. 

Hope this helps!

@Brandon Hall Thank you very much for your answer. How do they determine the improvement ratio of the property? Also, do you have to pay the "depreciation recapture" of 25% if you do a 1031 Exchange?

@Felipe Ocampo, I am not an accountant so these are just my best recollections.  When it comes to depreciation, the way I do it is to take the value of the whole property and subtract the land value.  If your property is worth $100K and the land is worth $10K then your amount you can depreciate is $90K.  I believe the depreciation on a building is like 29 years or thereabout.  So you get to deduct 1/29th of its value per year.  So say roughly $3K of your $90K building.  When you put in carpet or a water heater, you generally put those in and they increase the value of your property but since they have a shorted life span than the house you can often depreciate those on shorter terms.  There are tables to tell you what length of time you can claim depreciation.  Hopefully this helps you understand a little of how it works.  I am sure any accountant could explain it better.

Example, you buy a house for $100K, pay $20K down , finance $80K for 30 years at 5% interest.  Payments are about $430 per month.  Your taxes are $600 per year and your insurance is $600 per year.  You pay $1K for financing costs, you rent it out for 1K a month, and $500 to a plumber for repairs, and $500 to an electrician for repairs to wiring.  At end of year your income would look like this:

Rent income $12,000

Expenses

Repairs                     $1,000

Taxes                        $   600

Insurance                  $   600

Loan fees                  $1,000

Total costs                 $3,200

Mortgage expense    $5,160

Cash increase           $3,640

Your mortgage payment is NOT tax deductible, but your mortgage payments had about $4,000 of your payments be towards interest and about $1,400 towards principal, so you can deduct the $4,000 interest, and you get $3,000 in depreciation.  So you have $3,640 in the bank from your rental, your total income is $12,000.  For taxes you deduct everything but the mortgage payment so you have $8,800 taxable income.  Now deduct the $4,000 in interest and the $3,000 depreciation, you have $1,200 taxable income, but you have a $3,600 extra money sitting in your bank.  Does that help?

I 2nd what @Jerry W. states (although I depreciate my improvements over 27.5 yrs). 

 I just looked up what my assessor said my land value was.  It's online or on the value notifications the county periodically sends out.  There are probably different methods to get to your improvement ratio, but county assessed land value seems reasonable in my area and it's easiest for me.  

@Jerry W. that was very helpful. Thank you very much. By the way, did you mean you end up with $1800 of taxable income instead of $1200? Or am I missing something else?

$12,000-$3000(depreciation)-$4000(interest)-$3200(other expenses) = $1800

@Steve Vaughan Thank you. So if the building is over 27.5 year you cannot get depreciation deductions from the property itself(just from capital expenses made)?

Hey @Felipe Ocampo, I meant $1,800 hehe.  I was doing estimates in my head not on paper.  Sorry.

Thanks all for your contributions......this is very helpful.

@Felipe Ocampo

Thanks for the post...

No, you still take it from the property itself.  Jerry's post said "29 years or thereabout".  I was just being more specific - 27.5 years.  It would increase the depreciable amount a little bit in his example.    

Ok. So the property starts the "depreciation" the moment when you rent it out(not the moment the property was built, which was my confusion) and you will get that tax deduction for 27.5 years or until you sell it. I initially thought if the property was 10 years old when you bought it and rented it, then you could only get 17.5 years of the depreciation tax benefits. 

@Felipe Ocampo

I believe you are getting incorrect or incomplete information in response to your questions. There is a forum on BP specifically for income tax related questions such as yours.

For depreciation, you DO NOT use the tax assessor's estimate of the value of the rental property you just purchased to determine your depreciation basis.  You use the actual amount you paid for the property.  Use the tax assessor's improvement ratio to determine how much of your purchase price was allocated to the dwelling structure and how much to the non-depreciable land.  

For example,  let's say you purchase a property for $75K.  You put about $10K into the property to make it rent ready.  Your cost basis for this property is now $85K.  The tax assessor says that the tax valuation for the property is $125K of which $100K is the value of the improvements and $25K is the value of the land.  According to the tax assessor's valuation, the land value is 20% of the total value of the property ($25K/$125K).  This means that 20% of your purchase price or $15K ($75K x 20%) is allocated to the land and the $60K balance of the purchase price is allocated to the dwelling structure.  

Now, the costs incurred to make your property rent ready are added to the $60K value of the structure to arrive at an initial depreciation basis of $70K in this example.  If you divide $70K by 27.5 years, you can take a $2545 depreciation expense deduction for each full year of ownership over the next 27.5 years that the property is used as a rental. Depreciation starts the first month that the property is ready and available for rent.  The first year of depreciation will be pro-rated to the month the property was "placed in service" and will be pro-rated again for the year the property is sold or for the last year of the depreciation schedule.  The IRS website has a downloadable IRS pub that explains how to compute depreciation, what can be depreciated, and how to pro-rate the first and last year.  

@Dave Toelkes Thanks for the information! Got it. So you use the actual amount of what you paid for the property. Not what the property is worth at that time or at the time of doing your taxes. That is a bit unfortunate since you cannot deduct the additional appreciation that the property will have over the years. That is great to know. 

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here