The basic concept of depreciation is that your investment property is made up of two parts, the land and the improvements on the land, i.e., your house.
Appraisers will assign percentage values to your property based on these two parts. For this example, 20% of the value is the land and 80% of the value is the improvement. Over time, the house will deteriorate, the government (check with your tax advisor to make sure you qualify) lets you write down that 80% value over a certain number of years depending on the type of real estate. For residential homes, it’s 27.5 years.
So, your $100,000 property has $80,000 that can be depreciated over 27.5 years, which equals $2909 per year. This amount is listed as a loss of income, even though no money is coming out of your pocket.
Let’s assume you are in a 30% tax bracket. That means that applying 30% to your depreciation of $2909, nets you $873 in annual tax savings. Tax savings is the exact same as an increase in income. More net in your pocket, which is the ultimate goal. Return on investment: 4.3%
- Land cannot be depreciated. Only the building and certain contents.
- appliances including refrigerators, washing machines, dishwashers, and stoves
- capital improvements such as a kitchen or bath remodel
- new windows
- full roof replacement
- leasehold improvements such as electrical system overhauls or new septic systems
- landscaping improvements
- legal fees, if carved out separately from the original purchase amount, and
- equipment used to maintain the property, such as landscaping equipment or cleaning appliances.
Make sure you have a good tax professional on your team, with some real estate investing experience, in order to maximize these profit centers. You'll likely find that they will more than pay for themselves.
How do they all tie together?
Cumulative total returns
Leveraged 100k house cumulative returns
- COC - 12%
- Appreciation – 21.7%
- Amortization – 10%
- Depreciation: 4.3%
- Total for all 4 profit centers: 48%
Coach's Corner – Personal Development Tip or Book or Quote
"I'm convinced that about half of what separates the successful entrepreneurs from the non-successful ones is pure perseverance."--Steve Jobs
"Continuous effort--not strength or intelligence--is the key to unlocking our potential."--Winston Churchill
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