As physicians, we have great earning power—a nice reward for the years of training and sacrifice. Unfortunately, with great income comes a great tax bill. And while, yes, you can write off certain items to reduce your taxable income, a stethoscope and a few pairs of scrubs won’t make much of a dent at the end of the year. Because of this, we must find a way to reduce the amount of taxes we pay to keep more of the income we earn. Here’s where real estate comes in, providing one of my favorite tax benefits: depreciation.
Behold, the miracle of depreciation
Depreciation is the decline in value of an asset over time. For example, when you buy a new vehicle, it loses value (depreciates) the moment you drive it off the lot. However, while the term depreciation typically has a negative implication, in real estate investing, it is positive, because the government greatly incentivizes business and real estate owners through this concept.
Nearly all items related to the property (toilets, sinks, stoves, fixtures) are depreciable with the exception being the land on which the real estate sits since it is considered a fixed cost. Tax laws provide amazing opportunity by allowing asset owners to deduct the structure’s depreciation, therefore reducing their taxes. This video provides a more detailed explanation and breaks it down with examples:
Plan Now to Save Later
The key to fully benefit from depreciation is in planning. As Mike Pine, CPA, of Pine & Associates CPAs, points out, once the fiscal year is passed, you are stuck with the previous years’ details. You MUST plan for the year or years ahead. By doing this, I’ve managed to greatly offset my income to keep more of what I’ve earned through not only my profession but my real estate investments. So not only am I making more, but I’m also keeping more.
Now, take this a step further. The asset that is providing the opportunity for depreciation also is appreciating over time, thus creating more equity while the value of the building depreciates, thus reducing its tax basis. This, in turn, reduces the amount of taxes paid on the assets that are appreciating in value simultaneously. I’ll take it!
I’ll close by saying that while it is important to understand this concept, it is not something you have to work out on your own. If I’ve said it once, I’ve said is a million times, successful real estate investing is a team sport. Add a trusted tax advisor to your team to help with the details to maximize your profits and net worth.
I’d love to help with questions and hear how depreciation has changed your balance sheet! Let me know!