In commercial real estate investing, the benefit of appreciation is obvious to beginning and experienced investors. In general terms, it's an increase in the value of an asset over time. We can all get on board with watching assets grow in value, preferably ahead of inflation.
However, depreciation is not so obvious and often underrated. It’s an accounting method that tracks the physical or tangible asset over its useful life. Depreciation is about how an asset is used, and you can use it to your advantage. Here are my five things every investor should know about depreciation:
Depreciation can be just as valuable as cash. Commercial depreciation is a critical tool and tax shelter every investor needs to understand. A legal depreciation strategy can contribute to your bottom line and optimize profit margins.
Depreciation allows you to earn revenue, while expensing the in-use portion of CRE. If the property meets the criteria, savvy investors depreciate long-term assets for both tax and accounting purposes. Check with your accountant to see if your property qualifies and what strategies would work best for your situation.
Take advantage of cost segregation when possible. It’s a tax strategy that utilizes accelerated depreciation deductions to increase cash flow, while reducing federal and state income taxes paid on income earned from rentals. It involves itemizing and reclassifying interior and exterior elements of a building which depreciate more quickly than the structure itself. Running a cost segregation study, conducted by a qualified engineers or CPAs, can get you the information you need.
Depreciation begins when the property is in-use, not on the purchase date. Therefore, property owners cannot claim depreciation until rental income is generated. It ends when the entire basis (the acquisition costs minus the cost of the land) has been deducted/recovered or the property is removed from service (sold).
The IRS sets depreciation periods (39 years for CRE) to take into consideration the quality of a building. Poorly constructed buildings have a shorter lifespan than those built with quality materials and construction. According to the IRS, buildings get “used up,” not land, so land cannot be depreciated. Its value is determined through property appraisal or tax assessment.
Depreciation can save you a lot of money on your taxes. Be sure to partner with qualified advisors to make legal and strategic actions with your CRE investments. I’m here to help if you have any questions (612-788-1552 or jeff@CEGspaces.com).
Jeff Salzbrun is the owner and broker of Commercial Equities Group (CEG). As a veteran-owned real estate brokerage, CEG has been involved in many sale and lease transactions, ranging from single offices to 250,000+ square foot buildings. At CEG, we get your deal done. We know space, and we know the CRE business.
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