Tax Savings from Rental Properties

[Rick D.]

I realize a real estate investor “makes money” in four basic ways.

• Cash Flow,
• Appreciation,
• Principal Reduction, and
• Tax Savings.

In order to properly estimate my returns I need to assign a dollar value to each of these. The first three are easy to calculate after having made a few basic assumptions, but I need help on #4.

While I understand every individual’s tax situation is different and complicated, there must be a way to make some basic assumptions and estimate this as well. If I ignore 1031 exchanges, ignore deductible property improvements, etc, and assume the following parameters:

Purchase Price:                  $100,000

Property Type:                   Residential (so, 27.5 years of depreciation)

Annual Depreciation:        $3,636

Marginal Tax Bracket:       28%

Est. of Taxes Saved:          $1,018   (= 28% of $3,636)

Is this a reasonable way to estimate money "not paid in taxes" in order to put a dollar amount on #4?

Thanks in advance,

- Rick

[Paul Allen]

@Rick D. Reasonable with the limitations on passive losses previously addressed. Be aware, though, the tax savings on depreciation are borrowed from, not given by, the IRS. If you sell the property you are expected to repay the "depreciation recapture".

The exceptions to this would be:

1) You die owning the property. (Not the most pleasant tax strategy, but highly effective!)

2) You do a 1031 exchange

3) The property actually depreciates (rare for rental real estate properties, but it happens)

It's still a good deal, but if you are including tax savings in an ROI calculation for a property you intend to sell, you should also reduce the tax savings by the depreciation recapture that you have to pay back when you sell the property.