Why Depreciation Is The Biggest Perk Of Real Estate Investing

28-May-2018

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Thomas Black, M.D., is the co-founder and managing partner of Napali Capital, a Texas-based real estate investment firm.

Investing for retirement is historically fraught with risk and fear. Investors in this group are generally older, ready to press on the brakes and work less yet still need a reliable source of income. Of the myriad opportunities available, one investment vehicle stands above the rest as far as consistency regardless of the current economic climate and has withstood the test of time through all cycles of the economy and various administrations. That vehicle would be real estate.

Real estate is a tangible and necessary asset. People must always have a place to live. Unlike paper assets, real estate can be rapidly liquidated and rarely depreciates. The income potential of multifamily housing is perhaps the most stable there is, given the multiplier of tenants. This is passive, real income that’s accumulating even as you read this. Though there are other investments that can yield passive income, real estate offers a unique feature that can greatly increase one’s return: depreciation.

Depreciation is the decline in value of an asset over time. For example, when you buy a new vehicle, it depreciates in value the moment you drive it off the lot. Just try to trade it in within a month of purchase and you’ll understand depreciation quite well.

Though the term depreciation implies loss, in real estate investing it is actually a positive as far as income is concerned. Real estate depreciates. Toilets, sinks, rooves and essentially all items that comprise a real estate investment are depreciable with the exception of the land itself. Land is a fixed cost and does not depreciate. Tax laws allow the owner of the asset to take a deduction for the structure’s depreciation. This is a key concept in real estate investing.

The value of a real estate investment such as an apartment complex, for example, can appreciate in value over time, thus creating more equity for the owner, while the value of the building depreciates, thus reducing its tax basis. This, in turn, reduces the amount of taxes paid on the assets that are appreciating in value simultaneously.

This is in stark contrast to income generated from employment. Generally, one is taxed on 100% of their income generated from salary. This is active income requiring work and you are taxed on all that you earn, whereas a real estate investment allows you to purchase an asset that creates passive income while also reducing the tax burden each year via depreciation allowances.

The take-home lesson is this: You can purchase real estate to create passive cash flow and simultaneously reduce your taxable income by the depreciation allowance, even though the asset is appreciating in value. Income is then increased actively by appreciation and passively by the decrease in taxable value using the depreciation allowance. No other investment vehicle can do this. Real estate is tangible, appreciable and a reliably predictable source of passive income that is insulated from economic downturns and inflation.

In short, it is the closest option to the perfect investment for a retirement portfolio. Unlike a mutual fund or stock, real estate has no annual fees or broker expenses. These other investment vehicles are also sources of passive income but are subject to fees that are often variable and prone to vary greatly in their returns based on the current market/economy. This relative instability can be particularly stressful for those relying on steady passive income.

The next time you are deciding on an investment strategy, ask yourself these questions: Are you paying a management fee? Can you reduce your tax basis by owning this, or will you accumulate more fees the longer you hold it? No, quite the contrary actually. If a portfolio manager sells shares of a certain company in the fund, the fund is taxed and that tax fee will be passed on to you, the investor.

Now, how does real estate investing sound to you? No hidden fees and an appreciable asset that is allowed a depreciation for tax purposes make real estate a no-brainer choice to me, and I suspect you’ll see the clear advantages of real estate investing over any other investment opportunity out there.

https://www.forbes.com/sites/forbesrealestatecouncil/2018/03/09/why-depreciation-is-the-biggest-perk-of-real-estate-investing/#4c8e466e7471

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