Hi everyone! I reference depreciation and in a lot of videos, so
if you don't know what I'm talking about, this video is for you.
Depreciation. What is this?
Well, we often hear about our appreciation.
What we hope our investments do.
And maybe when we're referencing cars,
a lot of times we talk about depreciation was the difference appreciation.
Like I said, is when something goes up in value.
Depreciation is when something goes down in value.
Now, from a tax perspective, the depreciation deduction
that you get is not actually a real expense most of the time.
So this is super important to understand because what
it really is is it says you've made some big expenditure.
So unlike buying, you know, supplies for the office, those usually get consumed
pretty quick or have a short what we call a useful life.
And so you just take a write off right away for it.
When it comes to larger purchases like real estate,
you have something that you're buying that's going to last many years.
So depreciation does is it basically
is the write off of that cost over time.
So you take whatever the cost is and you divide it by some formula,
you know, some amount of years and you get what your annual write off
is in any given year.
Now, the amazing thing about real estate is over a long period of time,
it goes up in value generally.
But from a tax perspective, you're actually basically treating it
as if it's going down in value, which is giving you these deductions
that benefit you and reduce your income.
So this is really I mean, that's why I call it the fake deduction.
It really has no basis in reality.
It's just a freebie deduction that you get.
And sure, you can get this deduction in other businesses.
You know, if you're purchasing large equipment or you're buying cars
or you're buying whatever large expenditure there is.
But most of those other items that are not real estate
that you're depreciated depreciating, they may not go down
in the same rate that the IRS says.
You have to deduct that, but they are going down in value.
So it's really a huge benefit to be able
to take a deduction for something that's actually increasing in value.
So now I'm going to go into more of how you actually look
at different types of property and what it means for your depreciation
deductions.
OK, so let's jump into the specifics here.
Now, I've just laid out four different categories,
and what these are is basically the IRS has said,
if your property is in one of these categories, it's going to determine
how long you have to take depreciation deductions.
Now, I don't know who came up with this or really what the basis is.
It's really just numbers that someone made up.
At the end of the day, it doesn't matter.
They have no real basis.
And what's actually happening to the value of the property
is most of the time first residents.
27 and a half years.
This is any type of residential property you know where people are living there.
So this can be a single family home.
This could be a duplex.
This could be a large apartment complex.
Even though, you know, in the real estate world, you may refer to larger
apartment complex as commercial or the depreciation world.
Residential means someone's living there.
That's the bottom line.
Commercial is now a business.
People are not living there.
That type of property has to get depreciated over 39 years, so a lot longer.
The next category is what we call land improvement.
So these are the items that are not part of the building itself,
but they're really operating as part of the building a lot of times.
So, for example, the parking lot, when you pull in sidewalks, maybe exterior
lighting or fencing, things like that are referred to as land improvements,
and those are going to take a 15 year depreciable life.
The last category we're going to talk about is personal property.
So these are items that really you can pick up and move.
That's what this is.
It's not real property.
It's not stuck in place.
You don't have to in order to move it, demolish it or something.
So this type of property is going to be five years.
So think of maybe like your computers or furniture
or when we really get more into breaking things down the carpeting
or other maybe components of the real property.
And if you're not sure what I mean by that?
Check out our video on cost segregation.
We'll go into more detail on how you break down
different components in a building and what benefits that gives you.
Now, one important thing to remember land is not appreciable.
So when you buy real estate, you have.
Have realized that a piece of that is related
to the land, that the improvements sit on.
And then another part of that value is related to the improvements
that are on that land.
So you have to figure out how much is land because you can't depreciate that.
So this is really important to realize.
So let's do a quick example on how this depreciation works.
And here you can see we're assuming you bought a house for 350,000.
And we're going to say that we've determined
that of that total cost tour 75 relates to our depreciable building.
That means the other 75 is the land, which is not depreciable.
So how do we figure out what our deduction is?
Pretty simple here.
We just take our two 75 of building value.
Divide it by the depreciable life in years for residential property,
and we come up with $10,000 as our fake deduction every year.
So that's kind of a quick and dirty way of how you would calculate depreciation.
And of course, if you have different types of components
within this, like, for example, if you added something outside
there was exterior that was considered a land improvement.
You'd have to separately calculate the depreciation on that piece
or if you did a cost segregation study, which again, check out the video.
If you don't know what that is, then you could potentially break out
the different components and get a little more depreciation
than that 10,000 number to help your bottom line.
OK, what about exceptions?
Because what I've learned, if nothing else in the tax world is that there's
always exceptions, and then there's typically exceptions to the exceptions.
So here we have a couple exceptions
to your depreciation deduction and you might hear these around.
You know, they're they've been thrown around a lot.
These are huge piece of figuring out your depreciation
that is bonus depreciation and section
179 depreciation, which is creatively named
after the code section that this is actually comes from.
So what does this mean?
Bottom line on a very basic level is this means you essentially get
to write off the full cost of something in the year
you acquire it instead of having to take those deductions over time.
So this is a huge benefit.
So bonus right now you can write off the 100% of property that qualifies.
And generally, the property that qualifies is
what's considered personal type property, and there are exceptions.
But some of the things you can write off is, you know, if you put in carpeting
until a rental property, that's new, you can write that off right away.
Let's say you put in a new parking lot for your commercial property
that generally can be written off in the year you do it.
And then one 79 is more for a while.
It can be both personal type properties on a business like machinery
or things like that.
Sometimes cars that you're using in a business
you can write off in the first year you acquire it.
Or it can sometimes
fall into the real estate world where you can write off.
Maybe if it's a commercial property and you have to do tenant improvements,
you could write off some of those tenant improvements in the first year
instead of taking deductions over 39 years.
Or if you want to, for example, now
you can write off the cost of new h back units.
You know, the air
conditioning units, which you used to not be able to under one 79.
And there are some other exceptions in there.
But really, what this means is just make sure you're checking
with your CPA or account if you do new improvements
or something, whether you can write those off in the current year.
That way, you're aware of how it's going to impact you.
So that's the basics of depreciation.
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