Real estate crowdfunding is becoming a very popular way for investors to get into the real estate market. They don’t have to manage the day to day operations of the property, but will be able to obtain cash flow and a percent of the profits upon disposition. Most real estate investors understand the basics of depreciation, but may not understand the benefits as much as they should.
No tax section on real estate investing would be complete without a brief description of depreciation. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property. Most types of tangible property (except, land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable.
In order for a taxpayer to be allowed a depreciation deduction for a property, the property must meet all the following requirements:
• The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases.
• A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.
• The property must have a determinable useful life of more than one year.
Depreciation begins when a taxpayer places property in service for use in a trade or business or for the production of income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first.
It is a result of depreciation that your taxable income (from the K-1) will likely be lower than your distributive cash flow. This is a major benefit to syndication investors.