Depreciation is helping my taxes?

[Mary Jay]

Hi guys,

I think I am starting to understand why Robert Kiyosaki always runs to buy a property when he has an income from his business.

Please correct me if I am wrong in my example:

Lets say a person makes 100K per year (for simplicity) at his/her W2 job...

Lets say that person buys a 230K rental property. So then the cost of the land is 30K for simple math and the cost of the house on that land (the improvement) is 200K.

That means that over the next 27 years ( 200k divided by 27 years= $7,407 ) that $7,407 will be subtracted from the 100K that the person made at his/her W2 job?

So now the taxable income is not 100k, but  $92,593 (100k minus $7,407=$92,593)

Am I understanding it correctly?

I am so dumb when it comes to taxes... So please forgive me, I know my question is stupid...

[Ben Zimmerman]

Partially correct, although a minor point is the house is depreciated over 27.5 years, so your numbers would be $7272 per year instead of 7407.

You first need to add up all the income from rents, and then subtract any real estate expenses that you have for the year such as closing costs, mortgage interest, property taxes, insurance, property management fees, HOA payments, minor repairs, depreciation, and any other misc business write-offs that you are using such as maybe a home office deduction, milage to check up on your property, or anything else that you can legally claim as a business deduction for your property.

Once you have figured out your properties total gain/loss for the year, it will often show a financial loss because of all of the things that you can deduct as expenses.  This final loss for most people is capped at 25k per year can be deducted against your personal income if you earn less than 100k per year.  If your losses are over 25k for the year any amount over the 25k is carried forward to future years where you can potentially use it later.  This ability to offset income starts to phase out if you make over 100k per year.

These business deductions are separate from personal deductions that you might have.  Most people claim the standard deduction of roughly 13k if you are single, so you can still claim the standard deduction and also claim these business deductions.

Lastly keep in mind that this depreciation is a phantom expense and the amount that you depreciate needs to be repaid when you eventually sell the house.  This is known as depreciation recapture and is taxed at a rate equal to your ordinary income tax bracket up to a maximum of 25%.  So hypothetically if you sell the house after roughly 14 years and you had written off 100k in total depreciation and you are in the 30% tax bracket, you would owe 25k in recapture tax.  This recapture tax can be postponed indefinitely by not selling the property, or selling the property under a 1031 exchange and keep postponing, and repostponing the tax until you eventually die at which time this tax debt effectively dies with you and goes away entirely.