Imagine a world where you can declare an expense, without coughing up any cash, where you can legally tell the tax man that your property is going down in value when in fact it’s going up. This would mean fewer taxes, more money. Well, welcome to the wonderful world of real estate. The accounting method of depreciation and the IRS’s recognition of it makes this possible.
Today I sat with Ruslan Magidov, a certified public accountant with two decades of experience, to talk depreciation. We met in his office in the Los Angeles Westside.
“Depreciation is the accounting of wear and tear of an asset over a period of time. In tax terms, this loss in value is an expense that is tax-deductible,” Ruslan says.
He went on to explain that, in itself, the idea of writing off depreciation on an asset is not unique. For example, you buy a truck for your business and, of course, it will incur wear and tear and lose value. It’s only fair that you can write off the loss in value. But depreciation on real property is totally unique. Unlike the truck, the property goes up in value, not down. “For tax purposes you can depreciate it, even if in real terms it appreciates,” Ruslan tells us.
Rules do apply, though, as Ruslan explained:
1. Not all real estate qualifies. Typically only rental property, held long-term.
2. Only the building portion is depreciable, not the land.
3. The IRS sets the life for depreciation. For residential property, the IRS says it will die in 27.5 years—obviously buildings can withstand much more, but don’t tell the IRS.
An example to put it together:
Property purchase: $1,000,000
Land value: $600,000
Building value: $400,000
Using straight-line depreciation: $400,000/27.5 years = $14,545
That means you can deduct $14,545 every year for 27.5 years against the rental income. If annual rental income is $30,000, you pay taxes on only $15,455, instead of on $30,000. This is a big non-cash write-off. Now add your real cash expenses on top of this and you have some huge tax savings.
Welcome to the world of real estate.
Have questions for Ruslan? Post them below!
ABOUT: Ruslan is founder at Magidov CPA Firm, a full-service CPA firm located in Los Angeles and Burbank, CA, specializing in accounting, business management, tax, audits of financial statements, forensic accounting, business valuations, litigation support, and divorce accounting. www.magidovcpafirm.com