Depreciation in the simplest of terms is merely the admission that whatever we build on the dirt, and sometimes below, deteriorates over time. Things get old and wear out. Who’d a thunk? The idea is that the real estate investor has put risk capital into improved real estate, an asset that by definition will be subject to breakin’ down. Therefore the Internal Revenue Code (IRC) allows the owner to assign a ‘life’ to these components, with various options as to how.

Without turnin’ this into rocket science, if you own residential income property, except for the land (Yes, Technical Tommie, there are exceptions. Leave us alone.), you’ll divide the value of the investment by 27.5 years. Every year you’ll be able to apply that ‘loss’ (A paper loss, as you haven’t lost a penny.) to the property’s cash flow. If there’s any of that year’s depreciation left, it can then be applied to your job income. The IRS calls that ‘ordinary income’. Tell me that doesn’t come off as condescending.

So, if you paid $250,000, and the market says the land value is $40,000, you’d figure your depreciation like this. [Read more...]