In our discussion on ways an income property can make you money, we discussed cash flow, appreciation, and loan amortization. The last is tax shelter.

4. Tax Shelter. Tax shelter is a legal way to use real estate investment property to reduce annual or ultimate income taxes. Not unlike all tax matters, however, no one-size-fits-all, and the prudent real estate investor should check with a tax expert to be sure what the current tax laws are for the investor in any particular year.

• Purchase costs. As a general rule, most costs incurred at the time of purchase are deductable in the year of purchase. One exception being loan fees and points paid to secure a new loan for income property. They must be written off over the entire period of the loan.
• Operating expenses. All expenses you incur in in the operation of the property are deductable based on whether they are expense items or capital items. Expense items (when you fix or repair your property to maintain value) are deductible in the year you spend the money, and capital items (when you increase value or replace a component of the property, like with carpeting or new roof) must be depreciated rather than expensed in the year the money is spent.
• Mortgage interest. The IRS allows you to deduct the interest you pay on your mortgage.
• Depreciation. Also known as cost recovery in the tax code, the IRS assumes that your buildings are wearing out and becoming less valuable over time and therefore allows you take a deduction for that presumed decline. The nice thing about depreciation is that it’s a non-cash deduction that won’t affect your cash flow or require you to take out-of-pocket.

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