Can someone point me towards a website with a good explanation of depreciation, I have one rental and one possible lease option and need to know about depreciation.
There are many sites that will explain depreciation. You might try a GOOGLE search. Perhaps I may be able to make it clearer to you.
Rental properties are "equipment" needed for your rental business. Business expenses are deductible when calculating the profit of your business. You pay tax on profit, not on gross income.
You can deduct the full cost of certain items in the year they are put into service. Examples are postage and office suppliesThe IRS requires that the cost of certain items needed for business cannot be deducted entirely the year they are put into service and require that they be deducted over a longer period of time. In particular, they will define a "useful life" of the equipment. For residential properties it is 27.5 years. The idea is that the equipment "loses value" (depreciates) throughout its period of service.
Here is an example: Suppose you buy a house for $100K. The IRS will claim that part of the cost is the land that does not "wear out" so it cannot be depreciated. You might claim that 80% of the purchase was the improvements (house) so you can begin claiming your cost for the house when you purchase it. You cannot deduct all $80K in one year. You can deduct (depreciate) $80K/27.5 = $2909.09. This amount is subtracted (along with other expenses) from you income to determine your profit (or loss) upon which you will be taxed.
If you decide to sell the property in 5 years it may have gone up in value. Suppose it is worth $135K in 5 years and you sell. Your "basis" in the property at that time will be $100K - 5 times $2909.09 = $100K - $14,545.45 = $85,454.85 So, you will have a "capital gain" of $135K - $85,454.85 = $49,545.45. You will pay capital gains tax on this amount. Under current law most investors have a capital gains tax rate of 15%, however, the portion that was depreciated ($14,545.45) will be taxed at 25%.
For most rental properties that are heavily financed depreciation will produce a loss even when there is positive cash flow. This is one of the attractive features of real estate investing.
This is not the whole story, but, it explains the essentials. I hope this is of some help.
That helps alot, now how about this.
I bought a house for $25k for example and put say 5000 into it and refi'd for $40,000. I assume Im to take
40,000 - land value % 27.5 correct?
Your cost for the property in your example is $30K after your improvements. The value of the land is subtracted from $30K, and the amount that is left is your depreciation basis.
Your mortgage amount is irrelevant.
What did you do with the extra money you got from your refinance? If you spent it on personal stuff like credit cards or paying off your car loan, the interest on that amount is not deductible either.
There are many sites that will explain depreciation. You might try a GOOGLE search. Perhaps I may be able to make it clearer to you.
Rental properties are "equipment" needed for your rental business. Business expenses are deductible when calculating the profit of your business. You pay tax on profit, not on gross income.
You can deduct the full cost of certain items in the year they are put into service. Examples are postage and office suppliesThe IRS requires that the cost of certain items needed for business cannot be deducted entirely the year they are put into service and require that they be deducted over a longer period of time. In particular, they will define a "useful life" of the equipment. For residential properties it is 27.5 years. The idea is that the equipment "loses value" (depreciates) throughout its period of service.
Here is an example: Suppose you buy a house for $100K. The IRS will claim that part of the cost is the land that does not "wear out" so it cannot be depreciated. You might claim that 80% of the purchase was the improvements (house) so you can begin claiming your cost for the house when you purchase it. You cannot deduct all $80K in one year. You can deduct (depreciate) $80K/27.5 = $2909.09. This amount is subtracted (along with other expenses) from you income to determine your profit (or loss) upon which you will be taxed.
If you decide to sell the property in 5 years it may have gone up in value. Suppose it is worth $135K in 5 years and you sell. Your "basis" in the property at that time will be $100K - 5 times $2909.09 = $100K - $14,545.45 = $85,454.85 So, you will have a "capital gain" of $135K - $85,454.85 = $49,545.45. You will pay capital gains tax on this amount. Under current law most investors have a capital gains tax rate of 15%, however, the portion that was depreciated ($14,545.45) will be taxed at 25%.
For most rental properties that are heavily financed depreciation will produce a loss even when there is positive cash flow. This is one of the attractive features of real estate investing.
This is not the whole story, but, it explains the essentials. I hope this is of some help.
That helps alot, now how about this.
I bought a house for $25k for example and put say 5000 into it and refi'd for $40,000. I assume Im to take
40,000 - land value % 27.5 correct?
thanks
Nick
Your cost for the property in your example is $30K after your improvements. The value of the land is subtracted from $30K, and the amount that is left is your depreciation basis.
Your mortgage amount is irrelevant.
What did you do with the extra money you got from your refinance? If you spent it on personal stuff like credit cards or paying off your car loan, the interest on that amount is not deductible either.