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I realized that I didn't cover this as comprehensively as I should have... I ignored the fact that when you sell, you need to "recapture" (i.e., pay taxes on) the amount of the gain over the adjusted cost basis of the property.
To clarify, here's an example:
Let's say you buy a property for $500,000 and the depreciation amount is $10,000 per year (basically, the IRS agrees that the wear-and-tear on the property devalues it by $10,000 per year and lets you take that as a deduction). After 10 years, you've depreciated $100,000 of the property. That means that you've gotten $100,000 in tax deductions, but the IRS assumes that the property is worth $100,000 less than when you bought it -- the adjusted cost basis is $400,000.
Now, let's say you sell that property after the 10 years for $550,000. Because the IRS agreed that the cost basis of the property was only $400,000, you now have a "realized gain" of $150,000 (not just the $50,000 gain based on the original purchase price).
Your depreciation recapture gain is the full $100,000 that you took in depreciation over the past 10 years -- you'll pay taxes on that at your marginal rate. The rest of the gains ($50,000) are long-term capital gains that you'll pay 15% or 20% on (depending on your capital gains rate).
So, this depreciation tax deduction isn't free money. You are essentially delaying the payment of taxes on the depreciated amount until you sell the property. The benefits are the time value of that depreciation (you get the benefit now and owe taxes later) and potentially you save money if your future marginal tax rate is lower than your current marginal tax rate (though it could potentially cost you money if the opposite is true).
Nonetheless, depreciation is a huge benefit when buying investment property.
"Nonetheless, depreciation is a huge benefit when buying investment property."
What other benefits does depreciation entail other than deferring taxes?
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