In the article How I Bought my First Rental Property, I talked about how my wife and I embarked into owning a rental property 18 months ago.
It was scary in some ways because no one in my family had ever had success in real estate with the exception of owning their own home and selling it for a nice profit. As we were leaving, my mother had asked if we’d be able to sell it instead of holding onto it, and maybe break even after the broker’s commission. Then, she asked how we’d be able to buy another home if we still had this mortgage.
But those were not my concerns. This property represented my family’s future prosperity. If I went broke over 900 sq. ft. in North Carolina, then I obviously had no place investing any money into anything.
The first year, in fact, I “lost” about $12,000 on this property.
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Losing Money on Rental Properties
Before moving out of this house, I’d invested more than $9,000 into it. On top of that, I have flood, wind and hail, and homeowner’s insurance on the property, which is incorporated into the mortgage payments.
When I get my rent check of $819 each month from my property manager, I can pay the mortgage of $778, netting me a monthly profit, or cash flow, of $41.
Then, on top of this, my accountant (a CPA, not H&R Block) adds depreciation to the property’s expenses, driving losses up and my taxes down.
Depreciation Keeps Taxes Down
I am not an accountant, but I’ll tell you what I know from this process. A home, like a piece of business equipment, depreciates over a certain period of time. In this case, it’s 31 years.
I bought my home for $113,000, then invested $9,000 into it, so 31 years into $122,000 brings me an “expense” of almost $4,000.
This year, I might operate at a loss only because of depreciation, bringing me a return on my personal taxes, which is also called Phantom Cash Flow.
Phantom Cash Flow
If I invested no money into my property five years from now while benefiting from a positive cash flow of $100 each month, I’d still claim a loss on my taxes.
The reason for this is because, while I actually gained $1,200, depreciation would factor in a loss of $2,800.
If I’m in the 25% tax bracket, my return when I file would include an additional $700 from this “loss,” meaning that I actually made $1,900 on my property.
This may sound like small potatoes, but imagine if the mortgage is paid off earlier than 30 years. The tax savings along with the money coming in every month would allow an investor to buy another piece of property sooner, providing a better future for him and his family, which is the whole point of investing.
This is a nicely written article that explains how owning rental property can save you money, even if you aren’t physically pocketing money every month.
In the business world Real Estate is not the only item that is depreciated when it comes to taxes. Computer, Cell phones, Copiers, Vehicles and so on qualify for depreciation through their business use. This includes vehicles and tools used for the maintenance and upkeep of a rental property.
I’m lost. you say you are depreciating 120k- but you can’t depreciate land, only the value of the building. Land does not qualify.
Depreciation is calculated on the “basis” of a property. Which means its costs, plus substantial improvements. According to the blog post, he purchased the property for 113K and then put 9K into the property.
The author does not break down the value of the land and the building as required by the depreciation worksheet/form by the IRS.