How to Utilize Real Estate Depreciation To Your Advantage

 

Skilled tax advisors counsel anyone with business income to scrupulously report every dollar of revenue received, while aggressively claiming every possible legal deduction. Occasionally, deductions more than cancel out revenues, resulting in a Net Operating Loss. Net Operating Losses enable companies to report huge incomes yet still end up with no tax liability.

 

Once a net income of zero has been achieved, losses for that year cannot provide any further tax benefit. The big tax savings come from spreading these excess large losses out over multiple years, reducing or even eliminating one’s tax bill for up to a decade or more.

 

Prior to 2018, business owners had the option of carrying losses back for up to two years. The Tax Cuts and Jobs Act eliminated carryback losses but indefinitely extended IRS provisions that allow carry forward Net Operating Losses for up to 20 years, with an annual limit for these deductions of 80% of taxable income.

 

The rather baffling aspect of the tax code as it relates to real estate entrepreneurship, is that real estate professionals have the ability to claim large losses without really losing anything. The secret to this common practice is mastering the depreciation of property for tax purposes.

 

 At the present time, any business owner’s business equipment can be an asset of value. Some years down the line, however, that business equipment will break down or simply become outdated. For this reason, companies can deduct their investment in such machinery over the course of several tax years as a depreciation expense.

 

Even though buildings often do not lose value over time, real estate professionals can still claim depreciation deductions for these properties. The results are often paradoxical; meaning a property may actually triple in value while its owner simultaneously claims depreciation expenses over the same time period, suggesting that it no longer has any value at all.

 

One major obstacle to winning at the real estate depreciation tax game is the IRS requirement that depreciation expenses be spread out over a long time period. Typically, the time period is 27.5 years for residential buildings and 39 years for commercial buildings. Since money loses value over time, tax savvy real estate owners constantly search for ways to depreciate properties over a shorter time period.

 

This effort gave rise to the fine art of cost segregation. By way of example, consider the case of an individual purchasing and renovating a commercial office property. Rather than waiting 39 years to get the full depreciation benefit for the building, the savvy real estate investor would hire a team of engineers to identify elements of the hotel that can be separated out from the building as a whole for depreciation purposes. Examples include lighting fixtures, carpeting, fences, sidewalks, driveways, furniture and workout equipment.

 

Many of these items have a recovery period (the length of time over which depreciation expenses must be spread out) of only 5, 7, or 15 years.