SUMMARY

Depreciation typically implies loss but in terms of real estate it actually can become a benefit to you.   Steven takes you through the different types of depreciation and how you can use it to your advantage as the year comes to an end and tax season begins.  


Please note that these are tips based on experience and you should seek the legal advice of  your CPA first to see if you can take advantage of any of the tips shared. 

 

Key Takeaways

  1.  Depreciation allows a business or an individual to recover the costs of an investment over a set period of years. So when you’re making an investment, you’re able to recapture that investment that you made, back as depreciation.
  2. When you’re investing in a piece of commercial property, depreciation will show up as a loss of money, however you didn’t really lose money as you’re able to have that as a write off that reduces your taxable income.
  3. The incentive of not paying taxes upfront, and deferring that to a future date, allows for a greater return, and ends up being a better choice overall.
  4. The practice of “buy until you die” can defer taxes indefinitely, even upon inheritance to your family.

 

Resources Mentioned

Interested in connecting with other like-minded individuals? Then join our VonFinch Private Capital Network.  Learn more at http://www.vonfinch.com/invest.

Episode Transcription

Steven Pesavento 00:00
As we head into the end of the year, now is the time that many of you are making those last minute tax decisions on purchases and investments to help you be able to reduce or eliminate taxes that you might have to pay in this current year. And so, as we're heading in to that time of the year, many of you have invested in commercial real estate or other real estate properties, and you have depreciation that will be coming to you, or potentially, you're looking for investment opportunities that could bring depreciation that would allow you to leverage that with your taxes. So I want to talk through a little bit about the power of depreciation, why it exists, why the government wants you to take advantage of it, and most importantly, how you can still take action. Right now, in order to set yourself up for a better tax season and really paying lower taxes, I should remind you that what I'm talking about here is really based on my experience what I've seen personally, this is not meant to be tax advice or legal advice. So in order to cover myself, because this is the world we live in, you're gonna need to talk with your CPA about the details of your specific tax situation. So let's get into it.

Steven Pesavento 01:22
This is the Investor Mindset podcast and I'm Steven Pesavento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.

Steven Pesavento 01:45
Why does depreciation exist? And why is it that the government wants you to take advantage of it? The first key piece to understand is the tax code, the tax code itself. All it is is a treasure map that the government put together outlining all the different actions and behaviors that the government wants its citizens and its businesses to implement and to invest into so that they can incentivize you to be able to bring to market something that is needed, the government doesn't have the ability to go build all of these houses or make these big changes or employ all these people. We're in a capitalistic society. And the way that they do that is they create incentives using the tax code. So when you think about the tax code as a treasure map, and you realize that the government can be one of your greatest business partners, when you follow that tax code, you can get excited about it, you can get excited about the fact that when you follow these sets of guidelines, you get a benefit back in return. And so one of those benefits is taking advantage of depreciation. So what is depreciation depreciation allows a business or an individual to recover the costs of an investment over a set period of years. So it was originally created to incentivize the building of the railroad, which was very capital intensive, and allow those owners to receive and recover back the cost of those installations. So we'll see this in buying different types of machinery and a business or buying real estate or commercial real estate property.

Steven Pesavento 03:30
So commercial real estate has a 39 year depreciation schedule, meaning the value of that property is then divided up over 39 years, and you're able to receive back recover back that investment each year, over 39 years until essentially 100% of that has been recovered a commercial multifamily or commercial residential piece of residential property, you're able to depreciate over a 27 and a half year schedule. So when you're making an investment, you're able to recapture that investment that you made back as a as depreciation, which allows you to reduce your taxable income. And it gives a benefit that incentivizes individuals and business owners to make investments that the government wants you to make. So all of it is 100%. Legal, the government wants you to be able to take advantage of it. It was created in order to incentivize behavior, and that behavior is investing into things that our society needs. So when you've made a an investment into a piece of commercial residential property, you're often going to depreciate that over 27 and a half year schedule. Now, there's an additional piece of the tax code. It's called bonus depreciation. bonus depreciation allows you to take all of that 27 and a half year or much of it, all of it over immediately, in that first year that the investment was made. So essentially, what they've done is they've said, hey, it's so important for you you to invest into this type of asset that we want to give you the ability to take that depreciation all upfront, no need to wait 27 and a half years, we want you to take it all right away, which incentivize a lot of money moving into the industry, as well as really created a lot of housing for folks. So that's the reason why it exists.

Steven Pesavento 05:24
Now, there's something called cost segregation. And a cost segregation study allows you to individually look through a piece of real estate, and understand in which different types of property within that real estate actually are on a different depreciation schedule. For example, the entire building might be on a 27 and a half year schedule, but the carpet or the paint, or the cabinets, or the lighting, or the concrete might be on a shorter schedule, maybe that's five years, maybe that's seven years. And so that what that allows an investor to do is to gather and recapture that at a faster rate. So when we put them together with bonus depreciation, and traditional depreciation, you can take that all upfront. However, without bonus depreciation, you still have a phenomenal benefit, and you're able to increase the amount of depreciation you're taking on a much faster path. Why does this matter? Because as an investor, when you're passively investing, when you're investing in a piece of property, what you're able to do is you're able to receive that depreciation, which actually shows up on your tax return as a negative loss, it actually shows up as if you had lost money. Now, you didn't really lose money, but you're able to have that as a write off, that reduces your taxable income. So for a passive investor, you're able to write off passive gains, you're able to write off capital gains. Again, this can be a great benefit. If you've sold a business, if you've sold an investment that you made, if you sold a piece of property, if you've sold something from the stock market, you've made trades, then you've created gains, and you will pay taxes on those gains. However, with commercial residential real estate, you're able to actually take that depreciation, and reduce the amount of gains that you have. And oftentimes people when they're investing in commercial multifamily, for example, they won't pay any taxes on the cash flow that is gained while they have that investment out. Now, oftentimes, depreciation is recaptured. And you do have to pay a recapture tax. But oftentimes, what I've found is that the incentive of not paying taxes upfront, and putting that off, deferring that to a future date, allows for a greater return, and ends up being a better choice overall. On top of that, what many investors will do is they'll do what's called buy until you die, they will plan on buying and investing in real estate or investing in these assets. And then they'll continue to move the money from one property to another using a tender and exchange or selling the property and using again, depreciation to offset that new investment that they're making. And then when you family receives that property, at your death, they actually receive it without you having to pay any of those taxes. So this is one of the big benefits, of course, and why it makes so much sense is you not only are able to defer those taxes, but if you continue to follow that path, continuously throughout your life, you're able to defer those taxes forever.

Steven Pesavento 08:31
Now, one of the benefits that will often do is we'll refinance a property, we'll be able to pull that cash out, and then now you have all of your investment back, but you still have that depreciation, and you still have an asset that continues to pay you. So there's a lot of different ways to make this even more effective for you. And that's what's so exciting is when you can start learning some of these strategies around taxes and investments, and how the wealthy really think about money, you can understand how you can actually create even greater returns than you might have even thought was possible. So as you're getting into the end of the year, this is a time that a lot of people are looking for opportunities to create depreciation. This is why people buy cars at the end of the year. This is why investments will often happen. And so maybe you're not in a position to make an investment to affect this year's tax returns. So I recommend that you look forward to next year and you start planning ahead. But for those of you who have capital in the bank, and you are able to find good quality investments that create depreciation, they can really make a huge difference for you and for the investments that you're making.

Steven Pesavento 09:40
So if you're interested in getting involved in learning more about what depreciation can do for you, and how investing into commercial real estate can make be a key part of your investment portfolio. I encourage you to head over to vonfinch.com/invest register, set up a call with me or one of our advisors deserves to be able to dive in. And really help support you and understanding what might be the best path forward for you and your family so that you can make that best decision for yourself. So, with all of that, thank you so much for listening. If you liked today's episode, please do share it with your friends so they can learn about some of these strategies as well. And we'll see you on the next episode

Steven Pesavento 10:27
Thank you for listening to the investor mindset podcast. If you like what you heard, make sure to rate review, subscribe and share with a friend. Head over to the investor mindset.com to join the insider Club, where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.

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Steven Pesavento has always been obsessed with understanding how we can think better, how we can be better and how we can do better. He is an active real estate investor who curates Commercial Real Estate Investments for clients.

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