Appreciation: Appreciation occurs when the value of the property (asset) increases over time. People often focus exclusively on the value in today’s market, rather than looking at how much the property value may increase over time.

Build wealth: Wealth is the accumulation of assets that can increase in value. Asset acquisition builds wealth.

Cash flow: The income generated from the property, often through rental income.

Tax deductions: Unless you’re invested in a high-risk sector like oil and gas, most other investments do not have the various tax benefits linked to property ownership.

Stop giving your money blindly to someone else

To illustrate this point, the problem with investing in a mutual or indexed fund is that you don’t know anything about their management, their leadership, their marketing plans, etc. It’s also very difficult to track what exactly is happening inside the various companies included in those funds.

Moreover, real estate is a tangible asset that can be appraised to determine its value and that you can live in, rent, and/or use for business.

Understanding how depreciation works

Here’s the scenario, including the assumptions regarding the purchase:

The improvements without the land are worth $250,000.
You paid all cash for the property. (If you obtained a mortgage you would have to add that expenses to the insurance and property taxes in calculating your ROI (return on investment.)
Annual property taxes are $4,000 and annual property insurance is $2,000 (total $6,000).
You rent the property for $1,000 per month, or $12,000 per year.
You net $6,000 per year of profit.

Traditional approach to depreciation
The IRS says that the “useful life” of a home’s improvements is 27.5 years.
To determine your tax deduction, take the value of your property minus the value of the land and divide it by 27.5. In this case, $250,000 divided by 27.5 is approximately $9,000 ($9,090) a year you can deduct using the 27.5 useful life guidelines.
If you subtract $9,000 from your $6,000 profit, you now have a $3,000 loss. The cool thing is that did you really have a loss? The answer is, “No,” it was a paper loss provided by the IRS, so you get to keep your $6,000 of net income tax free.
If you are what is called an “active investor,” you can take the $3,000 loss directly off your W-2 or other income. 
If you are a passive investor, you can use that loss against any profit from another property. If you don’t have anywhere else to apply it, you will already have the $3,000 as a loss to apply on next year’s tax return.

Use a “Cost Segregation Study” to maximize depreciation
This approach takes the property you acquired and breaks it into little pieces that you can use to accelerate the depreciation. For example, doors, windows, sinks, tiles, appliances, etc. all have a life span. Instead of having the distribute the depreciation out evenly over 27.5 years at approximately $9,000 ($9,090) per year, you can probably take about 25 percent of the depreciation in Year 1. In this scenario, that would be $62,500 instead of $9,000.

If you take your $6,000 in rental income and subtract 25 percent in depreciation allowed using a Cost Segregation Study, you now have a phantom loss of $56,500.

How depreciation lowers your taxable income
Remember, there are two types of investors — active and passive. If you’re an active investor and you earn $100,000 income, you can deduct the full $56,500 from your income and only pay tax on $43,500. In addition, you will continue to receive a tax-free check of $6,000 each year, but that amount will increase if you make improvements or raise the rents.

In addition, real property typically keeps pace with or exceeds inflation over the long term, so perhaps it goes up to $257,000 after the first year, up to $267,000, and so forth.

An important warning: To maximize your tax write-offs, speak to your CPA, tax strategist or tax attorney first.

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