Depreciation questions that are stumping me

[Thomas Knight]

1. If you have started depreciating your property (which is based on the asset value not on the land) and you say, get it reappraised or you refinance it do you start the depreciation process over at the new adjusted value, or do you just continue with the old? or subtract the difference of the old value from the new? 

2. If you depreciate multiple properties for say 10 years, then decide to do a 1031 exchange for another property(ies) do you start the depreciation over for the new property or are you only allowed the original amount you started with? You could seemingly have infinite depreciation if they allowed you to start over each time you exchanged or refinanced.

I've read a bunch of books but haven't really seen these questions posed anywhere. Thanks for the help!

[Erik W.]

@Thomas Knight, there is no "lost" depreciation.  Depreciation (which is a TAX concept) says that the item you purchased on Day X is gradually wearing out.  Refinancing doesn't change the degree to which a property is wearing out.  Sun, wind, rain do.

When you 1031, all you're doing is carrying over the profit and applied depreciation from Old property to New property.  You lose nothing...it just comes along.

Lets say you owned a house purchased for $275,000.  You depreciate $10K per year based on residential depreciation schedule of 27.5 years.  Kept it for 10 years, taking a total of $100K deprecation, leaving $175,000 still to take.  Let's pretend the value did not go up even $1 and you put $0 worth of capital improvements into it, so you sell property A for $275,000 and purchase property B for $500,000.  Well...according to the IRS you should now pay a 25% recapture tax on the $100,000 worth of depreciation you took.  BUT, you do a 1031 exchange and the IRS says you carry that $100,000 "profit" with you to property B to help with the purchase price.

The beautiful thing about depreciation is it is a TAX concept only with no basis in reality.  What we know is usually the value of property increases, so long as you do basic maintenance it should never truly "wear out".  Plus if you segregate your costs correctly, often you can keep your capital improvements partially or fully below the $2,500 "de minimum" safe harbor and you can expense it immediately in the current year vs. adding it to your cost basis.

Deprecation--paper loss--is one of the great misunderstood benefit of real estate investing.  Learn how to take advantage and profit from it.

P.S. If you die still owning that piece of property we discussed earlier, even if it is fully depreciated and worth $0 in the eyes of the IRS, and leave it to your heirs in their estate, they will inherit it on a stepped-up basis (i.e. whatever a fair market value appraisal says it is worth), and they can sell it anytime within 6 months of taking ownership for the FMV price and pay ZERO (nada, zip, zilch) in either recapture or capital gain tax. Assuming your estate is below the limit for estate tax and tax law doesn't change. Or they can keep it as income property and start depreciating it all over again. See why I say depreciation is a TAX concept only with no basis in reality?

This is how generational wealth is built and one way you get to avoid taxes legally.  Too bad you have to die...   ;-)