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Why Invest in Real Estate?

July 24,2024 | Posted By Jason Risley in Buying

Investing in real estate offers several benefits. You can enjoy passive cash flow, property appreciation, and significant tax breaks.

Why Real Estate is a Smart Investment

There are three main types of tax deductions you can benefit from in real estate: direct, indirect, and phantom deductions.

Direct Deductions

Direct deductions are expenses directly related to owning a property. These include:

Mortgage interest
Property taxes
Insurance
Utilities
HOA dues
Repairs
Management fees

Indirect Deductions

Indirect expenses are costs you incur because you own rental properties, but not tied to a specific property. These might include:

Computer and cell phone expenses
Internet service
Accounting software

Always report your direct and indirect expenses, even if it leads to a temporary loss on paper.

Phantom Expenses

Phantom expenses, like depreciation, don't cost you actual cash. Depreciation allows you to spread the cost of an asset over its useful life, offering tax benefits without out-of-pocket expenses.

Understanding Depreciation

Depreciation is the IRS's way of accounting for the decrease in value of an asset over time. For rental properties, depreciation applies to the building, not the land. Different methods determine how quickly an asset depreciates. For most residential properties, the MACRS method is used, with a depreciation period of 27.5 years.

Steps to Determine Depreciation

1. Determine Your Overall Basis

Your basis includes the purchase cost and closing costs like property taxes, legal fees, and title insurance.

2. Allocate Part of the Basis to Land

Based on the fair market value, a portion of your basis should be allocated to the land, which is not depreciable.

3. Optional Cost Segregation Study

A cost segregation study can help allocate parts of your property to shorter depreciation periods, increasing your deductions sooner.

4. Create a Depreciation Schedule

If you want to calculate this yourself, go ahead—you'll see that the tax savings can be substantial. However, if you prefer not to, that's perfectly fine too. Most accountants are well-versed in handling these calculations for their clients. This schedule lists items, purchase dates, depreciation methods, and accumulated depreciation.

Maximizing Your Real Estate Investment

Investing in real estate not only provides passive income and appreciation but also offers significant tax savings. Understanding and utilizing tax strategies like depreciation can greatly reduce your tax burden.

By investing in real estate and applying these strategies, you can build wealth efficiently and legally. The more you understand these benefits, the more you can save on taxes and grow your investment portfolio.

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Mission Viejo, CA 92691

949-929-1575 / 714-980-1205

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