Renting and Calculating for Depreciation

11 Replies

I'm trying to understand the calculation for depreciation. I used a calculator and entered some numbers to find the yearly depreciation of a rental property. It tells me that it would depreciate in value by 7,700 a year. How is it possible to rent a home and at the same time make money if there seems to be so much money needing to be paid for.

Depreciation                7.7k
Insurance                     N.A.
Heating                        2.4k
Property tax                  4K
Mortgage Payment     15k

                          Total: 29.1

29.1/12= 24.25

I can't see how a tenant would pay 2425 a month to live in a home in my neighborhood.

Nice homes are renting for 1000 a month.

Example of a home in my area:  http://location.duproprio.com/4-et-demi-a-louer-st...


It seems a tenant would have a lot each month just for me to break even (pay the mortgage). I would have no surplus to reinvest back into the property for repairs and such.

Could someone please enlighten me on this? Thank you in advance!


Andrew

Are you trying to make expenses equal to rental income? Not impossible, but tough to do.

Depreciation is not an expense you pay. It is part of calculating the taxable income on a rental property (i.e. for tax purposes only). I highly recommend reading up on rental property financial analysis. Start with Frank Gallinelli's "What Every Real Estate Investor Needs to Know About Cash Flow...and 36 Other Key Financial Measures." Then read as many other books as you can off the BP reading list. Good luck!

Thanks for you comment @Andrey Y.  !


I will start the book tonight and I'll check out the rest! I am just wondering if you could enlighten on something though. Wouldn't you want to see depreciation as an expense because the bottom line is that  you'll be out of pocket in some way because of it? Or is it just a fact of life that income properties don't entirely get paid with tenant money even if it seems like it? @Melanie Smith   

@Andrew Jones it is highly possible on your market that a SFH won't cash flow without significant cash up front. But depreciation is an "expense" that only helps you. It is the government allowing you to deduct a portion of the non-land (ie structure and fixtures) value against your rental income, making your taxable income lower without having actually spent any money. This brings up another point - you should talk to an accountant if you're serious about investing as they are very knowledgeable about how this will all work for your specific situation. But I would go into that conversation having done more research - it would be expensive to pay a CPA for education that you can get for free here or at the library, but a good CPA will help you get the most deductions to protect any income you do have.

Depreciation is not an 'expense' per se, but its treated the same way ie. subtracts from your taxable rental income, same as taxes or mortgage interest.

The premise of depreciation is that, for a SFH, after 27.5 years the structure will be functionality obsolete and worth $0. This assumption is not correct in most cases.

How you came up with $7,700/year in deprecation is probably wrong too.  That assumes you are depreciating ~$210,000 of improvements.  Assuming 50% land value, that is an asset that you'd buy for $420,000 that only rents for $1,000.  

Originally posted by @Andrew Jones :

Mortgage Payment     15k

....

Nice homes are renting for 1000 a month.


There are a lot of misconceptions and math errors in your post, but regardless, these two things tell you everything you need to know...

If your mortgage payment is $1250/month, and your house is only going to rent for $1000/month, then you're losing money ($250/month) even before you factor in expenses...

@J Scott 

 So the solution would be to raise rent or find another neighborhood with a potential home that rents at a higher rate but has homes that are worth less? Sorry my math is skewed. However I'd like to thank you for your help!



@Steve L.  

The value of the land (of a potential home) is worth only 25% of the total value of the property. Though I do agree that the assumption is wrong. Thank you for your input!

The value of land v structure is not fixed either. The assessed values have a breakout but that's a snapshot in time and not set in stone. Your cpa can and will adjust those bases per your situation.

And your cash flow solution could also be solved with a different financing structure. There are many solutions. Read read read. :)

@Andrew Jones 

Frank Gallinelli's book is a good read, but you need to keep in the back of your head that some of the information is specific to the U.S.A. If you are looking at properties in the MTL area, better references - w/r to taxation and finance matters - would be:

  1. Cohen & Dubé: Legal, Tax & Accounting Strategies for the Canadian Investor;
  2. Gray, Douglas: "The Canadian Lanlord's Guiide"; and
  3. Boiron & Boiron, "Commercial Real Estate Investing In Canada".

The latter is essentially a text book which, despite having commercial in its title, would be a good reference for any investor.

1(506) 471-4126
Originally posted by @Steve L. :

The premise of depreciation is that, for a SFH, after 27.5 years the structure will be functionality obsolete and worth $0. This assumption is not correct in most cases.

How you came up with $7,700/year in deprecation is probably wrong too.  That assumes you are depreciating ~$210,000 of improvements.  Assuming 50% land value, that is an asset that you'd buy for $420,000 that only rents for $1,000.  

 Steve,

Depreciation - or, Capital Cost Allowance (CCA) in CRA terms - in Canada is calculated differently than in the U.S.A.   In this instance, the asset Andrew is considering would fall into CCA Class 1 and is depreciated at 4% per annum.   Furthermore, there are special considerations around the declaration of CCA in the year of acquisition.  However, assuming the $7,700 above was for a full year, the property value at the start of the period would have been $192,500.00

As an additional point, the land component of the property value would typically be 15 - 25%  (20% is commonly used).  Stepping outside this range, will be an invitation for an audit (i.e. red flag), so you will want to be able to backup the numbers.

1(506) 471-4126

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

Join the Largest Real Estate Investing Community

Basic membership is free, forever.