Depreciation allows you to lower taxable income on your rental property, and knowing when and how to reset it can maximize long-term returns.
If you’ve owned a rental property for years or are planning to invest in one soon, understanding how depreciation works and what to do when that benefit starts to shrink is critical to protecting your profits. Many investors end up with properties that have soared in value, yet their depreciation deductions have stayed flat or even disappeared. When that happens, the right moves can not only preserve your returns but also open the door to even greater long-term gains.
What is depreciation? Depreciation is a tax deduction that the IRS allows real estate investors to claim annually for wear and tear on a residential rental property. While this is only an accounting entry and not an actual cash exchange, it can have a real impact on your bottom line.
The IRS uses a timeline of 27.5 years for residential properties. For example, if you purchase a property for $300,000 and assign $75,000 of that value to the land, you are left with $225,000 for the structure itself. Dividing that by 27.5 gives you a depreciation amount of about $8,181 per year.
“By repositioning into a new investment, you can maintain your tax advantage and improve your overall financial outcome.”
This deduction reduces your taxable rental income. If your property brings in $25,000 in annual rent and you spend $10,000 on expenses like taxes, insurance, maintenance, and management, you are left with $15,000 in net income. Subtracting your depreciation deduction lowers your taxable income further. However, as time goes on and your property appreciates, your equity increases, but the depreciation amount stays the same. Eventually, you may lose the benefit of this write-off entirely.
1031 exchange. One way to maximize your return in this situation is through a 1031 exchange. This allows you to sell your existing rental property and purchase a new one without paying taxes on the gain, as long as you follow the IRS guidelines. Doing so restarts the depreciation timeline, giving you a fresh deduction schedule.
Over time, the value of the property and the rental income tend to increase, but the depreciation benefit on your original property remains fixed or eventually disappears. By repositioning into a new investment, you can maintain that tax advantage and improve your overall financial outcome.
Whether you’re preparing to sell, exploring a 1031 exchange, or considering buying your first rental property, understanding how depreciation affects your strategy is essential. If you have questions about the process or want to talk through your next move, feel free to reach out. You can call me at 904-405-1995 or send an email to Jeff@PursuitRealEstate.com. I’d be happy to help.
