Property Depreciation: Value?
I was reading that all depreciation taken on an investment property is subject to tax when the property is eventually sold. I am trying to understand this statement.
Does this mean that depreciation affects the cost basis of the property. For example, if you buy a property at $100K, own it for 10 years, depreciate 50% of the original price (i.e. $50K) and then sell it for $200k, one would have to pay capital gains tax on $150K ($200K sale price - $50K Depreciated value), Right?
Given that the above is right, what are the advantages of taking depreciation? Is the plan to postpone paying taxes till one is in a lower tax bracket? Is that the real benefit of taking depreciation?
Thanks in advance.
JS.
Andrew,
Thanks for the info.
Another question for clarification. If I own a rental property for 27.5 years and never depreciated during that period, Will the IRS assume that my cost basis is $0 and charge me 25% interest on my entire sale amont?
So I buy a property for $100K. Rent it out for 27.5 years and sell it for $200K. During that time I never take depreciation. So which of the following is the amount I am taxed one:
1) Profit = $200k - $100K = $100K
2) Profit = $200K - $0 = $200K
Thanks.
JS
Quote:
On 2007-02-27 15:11, Andrew_Bitler wrote:
The reason that people take depreciation deductions is so that they can increase their cash flow. Andrew,
You will have to explain this one. Depreciation is a phantom expense. It does not take any money out of my pocket, so therefore it does not affect my cash flow.
The depreciation deduction might reduce my tax bill but as far as my rental property is concerned, it has no affect upon my cash flow.
Quote:Another question for clarification. If I own a rental property for 27.5 years and never depreciated during that period, Will the IRS assume that my cost basis is $0 and charge me 25% interest on my entire sale amont?JS,
No. There are two components to the tax on the capital gain in your example.
The portion of your capital gain due to depreciation is taxed at 25%. The portion of your capital gain due to appreciation is taxed at 15%.
Capital Gain = Sale proceeds - Adjusted cost basis = $200K - $0 = $200K
Capital gain due to depreciation = $100K
Capital gain due to appreciation = $100K
Tax = $100K x 25% + $100K x 15% = $40K.
Quote:
On 2007-03-07 00:20, NewKidInTown3 wrote:
Andrew,
You will have to explain this one. Depreciation is a phantom expense. It does not take any money out of my pocket, so therefore it does not affect my cash flow.
The depreciation deduction might reduce my tax bill but as far as my rental property is concerned, it has no affect upon my cash flow.
I guess my wording is a little out of context... By increasing cash flow I was referring to segmented depreciation, and how asset separation can be used to accelerate you depreciation deductions.
In my perspective, cash flow is what is left over at the end of each month after debt service. This amount never gets bigger after taxes, but could be smaller after taxes.
If the depreciation expense allows me to keep all of my cash flow -- no tax bill -- then I have not really increased my cash flow. I just got to keep it all.
It should be pointed out that you cannot depreciate the land portion of the value of the property....just the structure and contents.
You choose a realistic portion of your property to allocate to structure and contents at time of purchase, and depreciate your choice per applicable depreciation schedule.
[addsig]
Quote:
On 2007-03-10 22:20, NewKidInTown3 wrote:
If the depreciation expense allows me to keep all of my cash flow -- no tax bill -- then I have not really increased my cash flow. I just got to keep it all.
By not paying taxes, I can purchase another investment. That will increase my cashflow.