Real Estate Investment Analysis: Modeling Rental Property Depreciation

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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Challenging Property Tax Assessments

Your annual property tax bill is based on your county government’s valuation of your property. Assessed values are often very different from the actual fair market value of your home. If your county assessment is too high, resulting in a property tax bill that is more than it should be, you can contest the property valuation in an attempt to reduce your tax bill.

The fair market value of your property is represented by the price that a typical home buyer would be willing to pay for your house. Arriving at the fair market value of your home without actually selling the house is accomplished by comparing your home to other houses that have sold. A proper comparison requires that the other houses be as similar to your house as possible. The best comparable properties will have nearly the same square footage and number of bedrooms and bathrooms as your house. In addition, they will be in the same neighborhood and will have sold within the last few months. This process is very similar to how appraisers determine the vale of your home.

There are two types of assessed value that local governments use to determine your property tax bill: Market assessed value and tax assessed value. Market assessed value is the government’s estimate of the fair market value of your home. This valuation is often based on the last sale price of the property, adjusted occasionally for appreciation. Since … Read the rest