Real estate is one of the most popular investment options out there, but it can be a bit confusing when it comes to taxes. One of the tax benefits of investing in real estate is accelerated depreciation. This article will explain what accelerated depreciation is and how it works in real estate investing.
What is Depreciation?
Before we dive into accelerated depreciation, let’s first define depreciation. Depreciation is the process of deducting the cost of an asset over its useful life. In other words, it’s the decrease in value of an asset over time due to wear and tear, obsolescence, or other factors.
For example, let’s say you buy a commercial building for $1 million. The building has a useful life of 39 years. You can deduct the cost of the building over 39 years, which means you can deduct $25,641.03 per year ($1 million divided by 39 years).
What is Accelerated Depreciation?
Accelerated depreciation is a tax strategy that allows you to deduct the cost of an asset at a faster rate than its useful life. This means you can take larger tax deductions in the early years of owning an asset, which can help reduce your tax liability and increase your cash flow.
There are a few different methods of accelerated depreciation, but the two most common methods are bonus depreciation and Section 179 depreciation.
Bonus Depreciation
Bonus depreciation is a tax incentive that allows you to deduct a percentage of the cost of an asset in the year it was purchased. The percentage varies depending on the year, but it’s typically between 50% and 100%.
For example, let’s say you buy a commercial building for $1 million in 2021 and you qualify for 100% bonus depreciation. You can deduct the entire $1 million in the year it was purchased, which means you can take a $1 million tax deduction in 2021.
Section 179 Depreciation
Section 179 depreciation is a tax incentive that allows you to deduct the full cost of an asset in the year it was purchased, up to a certain dollar amount. For 2021, the dollar amount is $1.05 million.
For example, let’s say you buy a commercial building for $1 million in 2021 and you qualify for Section 179 depreciation. You can deduct the entire $1 million in the year it was purchased, which means you can take a $1 million tax deduction in 2021.
How Does Accelerated Depreciation Work in Real Estate?
Accelerated depreciation is a powerful tax strategy for real estate investors because it can help reduce their tax liability and increase their cash flow. In real estate, the two most common assets that are depreciated are the building and the land.
The IRS considers the useful life of a commercial building to be 39 years, while the useful life of land is considered to be infinite. This means you can only depreciate the cost of the building over 39 years, not the land.
For example, let’s say you buy a commercial building for $1 million and the land it sits on is worth $200,000. You can only depreciate the cost of the building, which is $800,000. You can deduct $20,512.82 per year ($800,000 divided by 39 years) for the next 39 years.
Benefits of Accelerated Depreciation in Real Estate
Accelerated depreciation can provide several benefits to real estate investors, including:
- Reduced Tax Liability: By taking larger tax deductions in the early years of owning an asset, investors can reduce their tax liability and increase their cash flow.
- Increased Cash Flow: By reducing their tax liability, investors can increase their cash flow, which can be reinvested into other real estate opportunities.
- Improved Return on Investment: Accelerated depreciation can improve the return on investment for real estate investors by reducing their tax liability and increasing their cash flow.
Conclusion
Accelerated depreciation is a powerful tax strategy for real estate investors that can help reduce their tax liability and increase their cash flow. There are several methods of accelerated depreciation, including bonus depreciation and Section 179 depreciation. It’s important to work with a qualified tax professional to determine which method is best for your real estate investment strategy.
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