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Depreciation, How It Makes You Money in Real Estate Investment
Depreciation (or cost recovery) is defined by the tax code as a loss in value to a property over time as the property is being used.
The idea is that physical structures (called "improvements") do wear out, and the government (according to rules specified in the tax code) allows property owners to take a tax deduction each year until the entire depreciable asset is written off.
However, the amount of depreciation deduction is based on the rental property's useful life (the term used for tax purposes) and not nessarily the actual physical life expectancy of the physical asset.
According to the current tax code the useful life of residential property is 27.5 years, and for commercial real estate the useful life is 30.0 years.
For example, let's assume the Great Pyramid was built as an apartment complex subject to our current tax code. The owner could not depreciate it over the the thousands of years it has physically endured, but only over 27.5 years (its "useful life") as prescribed by the code.
For a property to be eligible for depreciation, the real estate property must be used in a trade or business or held for the production of income--an individual's personal residence does not qualify for depreciation deductions.
Moreover, the property must be something that wears out or loses its value from natural causes--only the physical structure and not the land can be depreciated.
For example, if you purchase a ten unit apartment complex for $700,000, of which you attribute $490,000 to the building and $210,000 to the land, you can only depreciate $490,000 and not the full $700,000.
Summary
The tax code permits depreciation deduction for income property (not one's personal residence) The useful life (not the physical life expectancy of the asset) becomes the depreciable basis Only physical structures (not land) can be depreciated
James R Kobzeff - 19 Sep 2006.
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