When it comes to building wealth through real estate, many investors focus on rental income and property appreciation as key components to driving growth, but there’s another powerful tool that allows you to pocket more money: depreciation.
Depreciation isn’t just an accounting term. It’s a valuable tax strategy that can significantly boost your returns. In this blog post, we’ll discuss how depreciation can help you build wealth as a property investor in Franklin County.
Depreciation is a tax deduction that allows property owners to reduce their taxable income and recover the cost of their investment over time.
The IRS acknowledges that buildings and improvements eventually wear out and lose value, so they allow property owners to deduct a portion of their property’s cost as an expense on their tax returns. You can depreciate the property’s building value as well as any capital improvements you make to the property. (As a side note, be sure you have a plan in place to manage your property’s unexpected expenses.
Here’s a simplified explanation of how depreciation works:
Let’s say you purchase a rental property for $300,000. The IRS determines that the building’s useful lifespan is 27.5 years. This means you can claim an annual depreciation deduction of approximately $10,909 ($300,000 divided by 27.5) against your rental income. You can do this for the first 27.5 years of owning the property.
If eventually you do sell your property for a profit, however, be prepared to pay taxes for “depreciation recapture” on the profits you previously avoided paying taxes on through depreciation.
How Depreciation Helps Investors Build Wealth
The ways in which depreciation helps build wealth lies in the tax benefits. Here are some examples:
- Reduced tax liability – Depreciation reduces your taxable rental income. In our example, that’s nearly $11,000 per year that isn’t subject to income tax.
- Positive cash flow – By lowering your taxable income, depreciation can increase your property’s cash flow. This extra cash can be reinvested into your real estate portfolio or used for other investments.
- Tax-deferred gains – Depreciation can help you defer capital gains taxes when you sell a property. When you sell, you’ll need to “recapture” the depreciation you’ve claimed, but this is typically taxed at a lower rate than your regular income.
The combination of reduced tax liability, increased cash flow, and potential tax deferral can help you accumulate wealth faster. And with more money to invest and compound over time, you may be able to realize significant gains. Before pursuing any tax strategy, it’s advisable to consult an accountant who can ensure you’re staying up-to-date with current tax laws.
To learn more about investing in Columbus, get in touch with our team at RL Property Management. We’ve been managing properties throughout Franklin County for years, and we’d love to help you achieve success with your investment. Contact us to learn more.