How does depreciation affect cashflow?

Question

I'm doing an analysis of one of my rental (BRRRR) properties.  According to my QuickBooks, I'm doing ok.  $480/mo cash flow.  Plus another $250/mo mortgage pay-down.  Feeling pretty good about myself.

But then I looked at the Income and Expense form my accountant filed with my 2019 taxes (Form 8825) and it includes $13K in depreciation.  So according to that, I'm -$8K for the year on this property.

How should I be looking at this?  Happy that I have $480/mo in my pocket?  Or every year I'm losing $8K because the property is degrading over time?  My cash flow numbers above don't include Capex withholding, only minor repairs as needed.

Caleb Genry · Answer

@Mike McCarthy that's a fantastic thing! You should be looking at both. Depreciation is the magic of real estate because historically it is an appreciating asset! That's exactly what you want, to be making money, but showing a loss for taxes.

Basit Siddiqi · Answer

@Mike McCarthyDepreciation is a non-cash expense that the IRS gives to real estate investors.The value of the property can increase in value and you would still be entitled to depreciation expense.I would say it is a plus and helps your cash flow eventhough it is a non-cash expense. Depreciation lowers your taxable income and decreases your chances of your rental property increases your tax liability.

Whitney Hutten · Answer

@Mike McCarthy The depreciation creates a paper-loss.  This can be added back in when going for financing, so it's not an income loss.  Sounds like a winner!

Steve Morris · Answer

Depreciation is what the IRS allows you to take off the price you paid for your improvements annually.  You can set it off against income earned by the property.  They don't allow you to take 100% of the price paid the first year.

Depreciation affects your CF AFTER TAXES.  It does NOT affect NOI or the value of your property, it's an accounting for taxable income.

If you sell the property and do NOT take the tax deferral (as with a 1031), you'll need to recapture all of the depreciation you took and pay taxes on it - So it's not a total free ride.

JD Martin · Answer

Depreciation is a magic elixir when it comes to RE, unless you own something that never appreciates, had no/negative cash flow for all the years you owned it and you sell it, wherein you have to recapture that depreciation as a taxable event.

If you never sell the property, you never have to recapture the depreciation as a taxable event. For 27+ years you get to ride that wave. In 27 years if you have some massive appreciation, and don't want to eat the tax bill, that's easy too - you just harvest out your profits at (hopefully!) 4% annual, walk with your cash, and then get to write off the interest for the next 30 years. There's virtually no other investment out there that gives you these kinds of opportunities.

Steve Morris · Answer

Depreciation is the way you expense the price of improvements over time.  It wouldn't affect CFBT since it is used for tax-shelter of income like mort interest is.

However, once you get past deferring the income tax on a property by selling without a 1031, you'll need to recapture it and pay 25% of the depreciation taken in tax.

How does depreciation affect cashflow?

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