• Accumulated depreciation is the total amount of depreciation a property undergoes from the time it’s first put into service
• Taken at face value, depreciation appears to be a negative but it can also be beneficial for real estate investors.
* A real estate investor benefits actively from appreciation and passively from depreciation.
Depreciation is a measure of the decline in value of an asset over a given period of time. Taken at face value, depreciation might appear to be a negative but it can actually have advantages for real estate investors.
The total amount of the decline in value charged against an asset since the time it was pressed into service is referred to as accumulated depreciation. The original price of an asset (the cost basis minus the amount of depreciation t determines its current (the net) value on a balance sheet. It shows how much of the asset has been written off and reveals the useful life remaining in the asset.
In most cases, an asset’s accumulated depreciation is listed as a credit under fixed assets on a balance sheet. In other words, accumulated depreciation is the total of all depreciation applied to an asset since its usage began.
In the case of a rental property, depreciation starts when the property is first available for rental. To illustrate this, consider a scenario in which an investor purchases a single-family dwelling in need of renovations on Dec. 1st. A month later, with upgrades completed, the investor lists the home for rent on Jan. 1st. A tenant is signed one week later, and they move in on Jan. 8.
Here, the property is looked upon as having been placed into service the day it was offered as a rental. Therefore, depreciation begins as of Jan. 1st — rather than on Jan. 8th — when the new tenant moves in.
The annual amount of deductible depreciation is determined based on what the property costs to acquire (cost basis), the amount of time over which depreciation is calculated (the recovery period) and the applied depreciation methodology.
Newly acquired residential properties are depreciated based upon an accounting technique known as the Modified Accelerated Cost Recovery System (MACRS), which spreads tax-deductible costs over 27.5 years. Considered the useful life of a rental property by the IRS, this is also the amount of time delineated under the General Depreciation System (GDS), which is most often applied to residential rental properties.
The cost of the land upon which the structure is built must be separated out of the purchase price, as land does not depreciate. This can be determined by applying either the fair market value of the land at the time of purchase, or the assessed real estate tax value at the time of purchase. Say for example the total cost of the house from our above example was $200,000 and the land upon which it rests is valued at $20,000. This means that 90% of the total cost of the house ($180,000) can be depreciated over the recovery period of 27.5 years, or roughly $6,545 annually.
Over the ensuing years, the accumulated depreciation of the property would be equal to the number of years that has passed since the property was pressed into service, multiplied by $6,545. In the case of our example here, this would total $19,635 over the course of three years.
As covered above, accumulated depreciation is the total amount of depreciation a property has experienced since it was first put into service. In accounting terminology, accumulated depreciation is known as a contra asset account, in that its value reduces the value of the asset
In other words, in the eyes of the IRS, the more depreciation that accumulates, the less the property is worth. This means that while depreciation is a negative, it works out to be a positive, because it reduces the tax burden the investor must shoulder.
Meanwhile, the property’s market value is likely to increase, as the value of real estate generally appreciates over time. This creates additional equity for the owner, even as its taxable value is being reduced due to depreciation. The net effect of this is that the amount of taxes paid on an appreciating asset decreases in relation to the property’s market value.
This means that real estate investors are in the unique position of having the ability to purchase a property to increase their cash flow, while simultaneously reducing their taxable income on that property. In other words, the investor’s income benefits actively from appreciation, and passively from depreciation.
Real estate is the only investment vehicle capable of providing this benefit. Moreover, it can be relied upon to produce a predictable passive income that resists the effects of economic downturns. Further, real estate investments can actually benefit from inflation. This is why many experts consider real estate an ideal investment for a retirement portfolio.
Even better, beyond the costs associated with purchasing a property (many of which are also tax deductible), there are no annual broker fees such as those an investor might encounter with publicly traded equities and similar investment vehicles. Moreover, those fees can vary, making them less predictable. This can be an issue for those counting on a fixed amount of monthly passive income.
These factors can make real estate an ideal alternative investment for portfolio diversification as a hedge against both inflation and market volatility. Traditional portfolio asset allocation envisions a 60% public stock and 40% fixed-income allocation. However, a more balanced 60/20/20 or 50/30/20 split incorporating 20% alternative assets may make a portfolio less sensitive to public market short-term swings.
With that said, direct ownership of rental properties can be a source of other issues, including maintenance, marketing activities, vetting potential tenants and the like. Investing in a real estate fund such as Yieldstreet’s Growth & Income REIT (real estate investment trust) offers many of the same benefits, without those concerns.
In the past, such opportunities were accessible only to an exclusive base of wealthy individuals and institutional investors who could buy in at very high minimums — often between $500,000 and $1 million. However, Yieldstreet was founded with the goal of dramatically improving access to alternative assets by making them available to a wider range of investors.
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