Real estate investors often misunderstand rental property depreciation. To help you better model this important tax benefit for your own real estate investments, and understand depreciation within the overall context of your real estate portfolio, we suggest using a real estate investment analysis software to help you.
Here’s how to model it with the Real Estate Financial Planner™ software in particular.
First, the user enters in some basic information about the property. Wave a magic wand over the info provided. Tada! The software calculates the yearly gross depreciation benefit. It does account for residential versus commercial properties (27.5 versus 39 years).
For example, for a $250,000 property with a land value of $50,000:
Value of Depreciable Building = Purchase Price - Land Value
$250,000 - $50,000 = $200,000
$200,000/27.5 Years = $7,273 Per Year
The software does take it one step further, though.
It asks the users to enter in their effective tax rate as well. Using the user input effective tax rate, the software estimates the actual tax benefit.
Gross Depreciation x Effective Tax Rate = Estimated Tax Benefit
$7,273 Per Year x 21.2% = $1,542
We call the $1,542 “Cash Flow from Depreciation”. The real estate investor can look at it as the extra cash flow this rental property provides.
We display this to the user as part of the Return in Dollars Quadrant™:
Side note: the depreciation benefit is the only benefit presented in after-tax dollars.
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