Effects of depreciation and interest expense.

[Account Closed]

Anyone able to shed some light on how you personally figure in the savings of interest expense and depreciation on your investment?  I have heard a ton about cash flow, but there is the other great tax benefits, although I don't know how to go about guesstimating or calculating what these might be.  Anyone with more knowledge care to share on either a specific method, or broad based thoughts on whether you would even take that into consideration when looking at an investment?

Thanks in advance. 

[Jon Holdman]

Like almost all money you spend on a rental, interest is just another pre-tax deduction.  There's no "savings" associated with it.  Its a real cost.  Its just paid from the gross income, not after tax income.

Depreciation is best thought of as a loan from the IRS.  You do get to deducted it from your revenue (rents received) when you're computing your taxable income.  If it puts you at a net loss, you might be able to use that to offset other income.  There are limitations, and those may reduce or eliminate your ability to offset other income.

The kicker is that depreciation reduces your basis.  That means your gains will be increased when you sell.  And the amount of gain up to the depreciation (taken or allowed, whichever is greater) is subject to a tax on non-recaptured depreciation.  That's currently capped at 25%.  So, if you're in the 28% tax bracket, you can deduct the depreciation which gives you a 28% tax break.  Then, when you sell, you pay the tax on unrecaptured depreciation at 25%.  Which is why I say its best to view the depreciation deduction as a loan, not a real deduction.

Of course the real trick is to die.  Then your properties transfer to your heirs and they get the stepped up basis as of the date of your death.