Depreciation, in the context of real estate, refers to the deduction of a property’s cost over time. This deduction is allowed by tax laws to account for wear and tear, age, and obsolescence. Methods exist that allow for a larger portion of a property’s cost to be deducted in the early years of ownership, compared to straight-line depreciation, which spreads the deductions evenly over the property’s useful life. For instance, methods like the Modified Accelerated Cost Recovery System (MACRS) can be employed on eligible properties. This system allows for significantly higher deductions during the initial years, tapering off later in the asset’s life.
Employing these methods on investment properties can provide substantial tax advantages. By increasing deductions in the initial years of ownership, the taxable income generated from rental properties can be significantly reduced. This results in lower tax bills and potentially a faster return on investment. Historically, these methods have been utilized as an incentive for investment in real estate, stimulating economic activity and promoting property development. The ability to reduce tax burdens through these methods has been a key driver in the growth of the rental property market.
