How to Reduce Real Estate Tax Liability with Accelerated Depreciation

As a real estate investor, it is important to always look for ways to minimize your tax liability. One way to do that is through accelerated depreciation. By using this method, you can deduct a larger portion of the cost of your property in the year that you purchase it. This can lead to significant savings on your taxes, which can then be reinvested into your business. Here is a look at how accelerated depreciation works and how you can use it to your advantage.

How Accelerated Depreciation Works

Accelerated depreciation is a method of claiming a larger deduction for the cost of an asset in the year that it is purchased. This is done by spreading the deduction out over a shorter period of time than would be allowed under normal depreciation rules. For example, if you purchase a property for $1 million and it has an expected life of 20 years, you would normally be able to deduct $50,000 per year for the cost of the property ($1 million divided by 20 years). However, if you use accelerated depreciation, you may be able to deduct $100,000 in the first year and then a smaller amount in each of the subsequent 19 years. 

The main benefit of accelerated depreciation is that it allows you to claim a larger deduction in the year when you will likely be in a higher tax bracket. This can lead to significant savings on your taxes. 

However, there are some drawbacks to using accelerated depreciation. First, it will increase your tax liability in future years when you will likely be in a lower tax bracket. Second, if you sell the property before the end of its useful life, you will have to pay back some of the deductions that you claimed in earlier years. 

How to Use Accelerated Deprecation to Your Advantage 

If you are thinking about using accelerated depreciation on your real estate investments, there are a few things that you need to keep in mind. 

First, accelerated depreciation is most beneficial if you are expecting to be in a higher tax bracket in the year when you purchase the property than in future years. For example, if you are planning on selling another property or taking distributions from your retirement account in the same year that you purchase the new property, then accelerated depreciation could save you money on taxes. 

Which system should I use?

The MACRS (Modified Accelerated Cost Recovery System) method is the most popular method of accelerated depreciation and is generally used for properties with a useful life of 20 years or less. The MACRS method assigns different depreciation rates to different segments of a property’s useful life, with the highest rates being assigned to the earliest segments. For example, under the MACRS method, office buildings would be depreciated over 39 years, while residential rental property would be depreciated over 27.5 years. 

The straight-line method is the simplest and most commonly used method of depreciation for properties with a useful life of more than 20 years. Under the straight-line method, an equal amount of depreciation is taken each year over the course of the property’s useful life. So, using the same examples as above, an office building would be depreciated over 39 years using the straight-line method, while a residential rental property would be depreciated over 27.5 years. 

While accelerated depreciation can provide some significant tax savings for real estate investors in the right circumstances, it is also important to seek advice from a Tax Strategist for real estate investors.

Jose A. Ramirez is an experienced and sought-after tax strategist who helps investors in the Real Estate industry, including those in the activity of Short-Term Rentals such as AirBNB and VRBO, Landlords, Wholesalers, Rehabbers, Flippers, Real Estate Brokers, and Realtors. Schedule an appointment with Jose A. Ramirez for any additional questions you may have about this recent event. Make sure you are subscribed to the Advanced Tax Advisors email list so you can receive current events just like this in the future.