What is depreciation for
real estate investing?
That's today's video.
Let's dive in.
Hey, there.
I'm Clayton Morris.
I'm the founder
of Morris Invest.
We're one of the
largest turnkey rental
providers in the country.
And today we're going to
talk about depreciation,
one of the all-important
reasons we even
invest in real estate
in the first place.
It's something
that's so powerful
that lets us keep more of
our money in our pockets
than sending it off to the
federal government come
tax time.
So let's put this
definition up on the screen.
What is depreciation?
Well, it's simply the reduction
in the value of an asset
over time due to wear and tear.
The government recognizes
that things fall apart.
And you have a great
rental property.
You've rehabbed it.
In 27.5 years--
those are the years.
I don't know why they
put that half in there,
but that's what the
government allows.
That over time, 27.5
years, they believe
that that property
will basically
fall to ruin, which
doesn't happen,
because we actually don't lose
the value of a home, really.
I mean, when you compare
it to the stock market,
a stock can go down to zero.
But rental property
never, ever goes to zero.
Sure, in a down economy,
you might see a little bit
of a dip in property value.
But over the long
term, you're not
going to see it ever
go down to zero.
It's, frankly, impossible.
So 27.5 years is
the amount of time
that the federal government says
your property will deteriorate.
Now, what's great is that
every year for 27.5 years,
you get to claim on your
taxes the depreciation
of that property to
offset your rental income.
So let me give you a
specific scenario, right?
Let's say the value of the
home that you purchased
was $50,000, the appraised
value about $50,000.
Now, what you need to
do is divide that value
by the 27.5 years, and
you will arrive at $1,818.
Simple.
$1,818 is what you would
get to claim on your taxes
every year as the depreciation
value for that house
in general terms.
Now, what does that mean?
Well, $1,800 comes off of
your overall tax burden.
So now if your rent every
year on that property
is $5,000 a year-- let's
say that property brings you
$5,000 a year in
rental income-- now I
get to offset that by $1,818.
So $5,000 minus the $1,800.
And that's what I would pay
taxes on, not the full $5,000.
Make sense?
It's a fantastic way to mitigate
your overall tax burden.
One caveat here is that the
land that the house sits on
is not depreciable.
So you cannot depreciate
the land value.
So I've gotten in
arguments before,
because I believe that
rental real estate is
the number-one way to create
passive income in this country,
and there's no better way.
And occasionally, people will
say to me, what about raw land?
What about owning raw
land and leasing it
out to people who want to
put mobile homes on there
or billboards or
things like that?
Raw land is another great
investment strategy,
but it is not as good as
owning rental real estate,
simply isn't, because of these
very reasons that you cannot
depreciate land.
Land doesn't lose its value.
It simply has its value.
It's set by the market.
And it's not going to--
you can't depreciate it
because it's going to
fall apart over 30 years.
It simply can't happen.
The house, a structure, a
car, an asset can fall apart.
So that is depreciation
at the basic level
of residential real estate.
Now, you could go
higher and more ninja
by hiring a proper
accountant who can do what's
known as a cost segregation.
This is high-level stuff,
folks, and it's not
for the faint of heart.
Cost segregation is in the
new tax code that came out,
I think about two years ago.
What the IRS said when
they changed the tax code
is this-- that
now we're not just
going to let you
depreciate the whole house.
We're actually going to let
you, as a rental property
owner or a real
estate investor, we're
going to let you depreciate
certain pieces of the house.
Perhaps the roof needs
to be depreciated
at a rate different from the
cabinets or the structure
inside the house,
whatever it happens
to be, the IRS was
basically saying,
by allowing what's called a
cost segregation to break down
these costs over multiple items.
Now, it can only be done
by hiring an accountant who
does cost segregations.
You cannot do it on your own.
You actually have to
hire them to do it.
And in some cases, if you
own many, many properties,
it could definitely
be worth your while.
If you don't have
many properties,
the cost of hiring
that accountant
might be offset by the
cost of the accountant
with how much you're
actually going to save
by doing a cost segregation.
But if you have many,
many properties,
that accountant will
actually fly into the town
where you own your
properties, spend
all day going through those
assets and breaking it down.
They have to be
licensed to do it.
You can't do this on your own.
But that, again, is a
high-level ninja trick
when you are ready to take
things to the next level.
It's worth having a discussion
with your accountant on
whether or not
you're in a position
to do a cost segregation.
Anyway, that's a quick
look at depreciation.
I hope you have a good
understanding of why
this is such a powerful
tool to help you keep
more money in your own pocket.
I'm Clayton Morris.
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