Depreciation and Multi-Family Properties: Everything You Need to Know
In order to be a successful real estate investor, it’s important that you know as much as possible about every aspect of your properties. The price that you pay for a property upfront is only part of the equation. Additionally, the amount of revenue generated by a property plays a key role in the success or failure of your investment. However, between what you pay for a property and what you get for the property, it’s crucial that you understand how to use other tools such as depreciation. If you’re an investor in multifamily properties, depreciation can be one of the best tools you have at your disposal.
What is Depreciation?
Basically, depreciation is the decline in value of a property or other asset over the course of time. If you’re new to real estate investing, let’s consider another example of depreciation. When you purchase a new vehicle, it automatically loses some its value when you drive it off the lot. If you don’t believe that, try to go trade the vehicle in for a newer one just a few months after you buy it. The dealership will not give you as much as you paid for the vehicle.
In the world of real estate, the details of depreciation may be different, but the concept is still the same. The value of the land itself will probably not depreciate. In fact, there’s a good chance that land goes up in value. However, the building itself, through natural wear and tear can depreciate.
Is Depreciation Good or Bad?
It seems counter intuitive to believe that your investment property depreciating in value is a good thing, but it can be. Obviously, you don’t want to let the property fall into a state of disrepair. However, the natural depreciation of a property can be a useful tool for investors.
The land that your multifamily investment property sits on is a fixed asset. That means that land itself never loses its value. However, toilets, sinks, roofs and other components of a property do. How can this be a good thing?
Depreciation is a useful tool to investors because current federal tax code allows real estate investors to claim this depreciation as a way to offset some of their profits generated by a property. When the structural components of a property depreciate in value, you can use some or all of that depreciation to offset profits on your taxes.
Rules Concerning Depreciation
According to Federal Tax Codes, you can use the depreciation of a multifamily property if the property meets all of these requirements:
- You anticipate the property will last more than one year
- You own the subject property
- You use the property as a means of income generation
- The property has a determinable lifespan, meaning that it loses value from natural causes
As long as you own the multifamily property, there is a good chance that the other three principles of depreciation will apply to your property. Under the law, you can begin claiming the depreciation associated with a property as soon as you place the property into revenue-generating service.
On the surface, the depreciation of a property may seem like a bad thing. Obviously, you want your multifamily investment to maintain its value. However, natural wear and tear is unavoidable, and you are legally allowed to use that wear and tear as a means to write off some income. Knowing how to use depreciation to your favor is an important part of being a successful real estate investor. Doing so ensures that you maximize your own net worth, putting yourself and your loved ones in a better position to experience long-term financial success. Make sure you consult with your CPA (find one with good real estate experience) to take advantage of all the tax codes related to depreciation and investment property ownership.