Every investor knows to “buy low and sell high.” If a piece of property has a low valuation that is expected to increase, then it would be a smart asset to invest in. But what about if the value is decreasing and is expected to continue to do so? Does it ever make sense to invest in a depreciating asset?

Depreciation plays an extensive role in real estate investment. Depreciation is a non-cash deduction that reduces an investor’s taxable income, which in turn lowers the amount of income tax they are required to pay. Depreciating properties are not losses that result from physical payments such as bills or other expenses. Instead, they are “phantom losses” because the IRS allows property owners to take a tax deduction based on the decrease of the value of the real estate. 

This creates the possibility for the owner of a property to generate cash flow from a building while at the same time showing a tax loss. This concept makes it clear that it absolutely can make sense to invest in a depreciating asset because it can lower overall tax liability and potentially save investors thousands of dollars.

It is important to remember that for any given property the building and its contents, not the land, is what depreciates. The real estate value is the sum of the values of the land and building, but only the building contributes to depreciation. The IRS designates the useful life of residential buildings at 27.5 years, so in order to calculate the depreciation expense yielded from a property, divide the property’s building value by 27.5. Next, multiply the calculated value by your marginal tax rate to arrive at to get your property tax savings from real estate depreciation.

For example, say an investor owns a residential property valued at $600,000, $400,000 of which is in building value. $400,000/27.5=14,545.45. Multiply that by the investors tax rate, say 35%, and we get $5,090.91 in annual savings. 

If properly utilized, depreciation can be an incredibly valuable tool for investors.