Depreciation - Income Property

 

             Depreciation is the loss in value of an asset / building over time due to wear and  

             tear, physical deterioration and age.  The cost of reproducing an income property

             can be recovered over the useful life of the asset which is determined by law.  Only

             the building can be depreciated and not the land.  Residential income property must

             be depreciated over a 27.5 year period using straight line depreciation.  Commercial

             income property must be depreciated over 39 years using straight line depreciation.

             Straight line depreciation stipulates that an asset must be depreciated by equal 

             amounts each year over its useful life.   

 

             Example:    You purchase a warehouse for $900,000.  The land where the warehouse

             resides is valued at $120,000.  The building is valued at $780,000.  Current law 

             allows you to depreciate commercial properties by equal amounts annually over 39

             years.  Your depreciation deduction for the first year is based on the mid month

             convention.  The day of the month that you purchase the property doesn't matter.

             You can only deduct half of the first months depreciation.  If you put the warehouse

             into service on June 1, you are allowed to deduct 6 and 1/2 months of depreciation

             for the first year.

 

                780,000 

                -----------     =    $20,000      

                    39

 

                                                                           20,000

              First Year Depreciation =   6.5   X  (  ---------  )     =    $10,833 

                                                                               12

 

             Accountants calculate a full year of depreciation for the  above warehouse 

             (commercial properties) by multiplying 2.56 % times 780,000 which equals 19968.    

             A full year of depreciation for residential income properties would be calculated

             by multiplying 3.64 % times the building basis.

 

             The depreciation deductions that you write-off in any year reduce you taxable 

             income thus increasing your profit for that year.  

 

             Capital improvements are subject to the same depreciation laws.  Capital 

             improvements include the following;  a new roof, a new furnace, an addition to a 

             building, siding, etc. 

 

             Example:  You have owned the above warehouse for about 7 years now and it is in 

             need of a new roof.   The cost of the new roof is $19,500.  You are allowed to  

             depreciate thecost of the roof over 39 years.  If you put the new roof on in July, you 

             are allowed to deduct 5 and 1/2 months of depreciation in the first year.  

 

                 19,500

                 ---------    =  $500

                 39

 

                                                                                         500

              First Year Depreciation (roof)  =   5.5    X   (  -----   )    =   $229

                                                                                          12

 

              Accountants would calculate a full year of depreciation for the roof by multiplying 

              2.56 % times $19,500 which equal 499.

 

              All depreciation amounts that you write-off in each year for the building and  

              capital improvements reduce your adjusted basis for the property thus increasing     

              the taxable profit you must declare when you sell.    

 

 

              The income property analysis we do will help you determine the impact

              of depreciation on a properties rental income and after-tax cash flows.  We will also

              calculate the impact of depreciation on the potential sales proceeds from an income 

              producing property.  Don't make a large investment with blinders on.

 Tien and Jim 

Your Real Estate Partners