For real estate professionals, understanding property depreciation can be a game-changer in maximizing tax benefits and boosting long-term profitability. Depreciation isn’t just an accounting term; it’s a powerful tool in real estate accounting that can significantly reduce taxable income, thereby freeing up cash flow for reinvestment and growth. In this post, we’ll walk you through the meaning of depreciation in real estate, how it impacts your taxes, and how MKS&H can help you make the most of this often-overlooked benefit.
What Is Depreciation in Real Estate Accounting?
Depreciation is the process of allocating the cost of a tangible asset over its useful life. In real estate, this typically applies to buildings and improvements—not land, which is not depreciable.
The IRS allows property owners to depreciate residential rental properties over 27.5 years and commercial properties over 39 years. This annual deduction recognizes the wear and tear, deterioration, or obsolescence of a property over time.
Example: If you purchase a residential rental property (excluding land value) for $275,000, you can deduct $10,000 each year for 27.5 years.
Why Depreciation Matters to Real Estate Professionals
For real estate agents and investors, depreciation can significantly reduce taxable income. This means you can keep more of your money to reinvest in other properties, pay down debt, or improve your existing portfolio.
Types of Depreciation Strategies
There are several methods and strategies to enhance the benefits of depreciation.
- Straight-Line Depreciation: This is the most common method used in real estate. It spreads the cost of the asset evenly across its useful life (27.5 or 39 years).
- Cost Segregation: Cost segregation separates personal property components (like fixtures, appliances, and landscaping) from the building structure. These components can be depreciated over shorter periods (5, 7, or 15 years), allowing for accelerated deductions.
Example: A cost segregation study on a $1 million commercial property might identify $200,000 in assets eligible for 5- to 15-year depreciation, significantly front-loading tax benefits.
- Bonus Depreciation: Under current tax law, qualified improvement property and personal property may be eligible for 100% bonus depreciation in the first year. This rule is subject to phase-out changes, and so, professional guidance is highly recommended.
Common Mistakes Real Estate Agents Should Avoid
Ignoring Cost Segregation: Many real estate professionals miss out on significant deductions by failing to conduct a cost segregation study.
Misclassifying Property Types: Depreciation schedules vary depending on whether a property is classified as residential or commercial.
Not Planning for Depreciation Recapture: When you sell a property, the IRS may require you to “recapture” depreciation deductions, which can increase your tax liability. Strategic planning helps mitigate this impact.
Practical Tips to Maximize Depreciation Benefits
- Keep Detailed Records: Maintain thorough documentation of purchase price, improvement costs, and asset classification.
- Use a Qualified CPA: Work with a real estate accounting expert to implement advanced strategies.
- Consider the Timing of Improvements: Renovations can increase depreciation potential. Time them strategically.
- Plan for Exit Strategies: Understand how depreciation affects capital gains taxes and structure sales accordingly.
How MKS&H Helps Real Estate Professionals
MKS&H offers personalized support for real estate professionals by helping with cost segregation studies, navigating bonus depreciation rules, classifying property types correctly, planning for depreciation recapture, and optimizing tax strategies for growth. Whether you manage a few rentals or run a large firm, our CPA team provides customized advice to make the best use of this tool and guarantee you’re on the right financial footing.
Take Control of Your Real Estate Tax Strategy
Depreciation is one of the most valuable tools available to real estate professionals, but only if you know how to use it effectively. When you partner with MKS&H, you get expert, real estate-focused accounting and tax advice. Contact us today to schedule a consultation and discover how much more your portfolio could be doing for you.
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into a truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture, and your business goals. This approach enables our clients to achieve their greatest potential.
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