How to Determine Depreciation Allowance Using Your Tax Bill
One of the benefits of real estate investing is the return on investment due to tax shelter.
These are paper losses the IRS allows you to deduct from the taxable income you receive from the real estate investment property. Namely, when you own an investment property, the IRS gives you an annual depreciation allowance to deduct against your income.
How do you determine your annual depreciation allowance? One of the methods you can use is your property tax bill. Look for two components:
- The assessed value of the improvements (the structures on the land)
- The total assessed value of the entire property
Since it is ratio we are looking for (not the actual dollar amount shown on the tax bill), use these numbers to get the percentage for the value of the improvements. Here is the calculation:
Assessed improvement value / Total assessed value = % value of improvements
Next, use the percentage you get from that calculation to determine the amount of improvements as follows:
% value of improvements x price = depreciable improvements
The IRS rarely challenges this method of determining depreciation, but proceed with caution. The ratio from your tax bill is not always accurate; and if not, your deduction could be unfairly limited.
Please feel free to preview a proforma income statement created by our real estate investing software that shows how depreciation allowance can affect your annual cash flow.
