Depreciation

What it is

Depreciation is one of the four wealth engines that make rentals compound harder than flips. Ross walks through all four in the Wealth Engines video. The four are appreciation, cash flow, equity paydown, and tax advantages — and depreciation is the main mechanism in the tax advantages bucket.

Here’s how it works from the video: “The IRS says that the land is great. Land is great, but the building, the structure, the house or the multifamily home, the apartment, whatever that sits on that land is depreciating in value. It’s getting worse every day. Even though you might have done a brand new renovation on it and it looks great, everything’s in great order, the IRS still says that’s depreciating in value.”

For a residential property, it’s a straight-line write-off over 27.5 years. Ross’s example: “Let’s say it’s $100,000. That’s what the property is worth. They’re going to say okay, 30% of that $100,000 is the land — $30,000. And the other 70%, $70,000, is the building’s value. And we’re going to say over the next 27 1/2 years, you get to depreciate that amount.” That’s $2,545 per year as a deduction. “Sweet, right? It’s a phantom write off.”

The magic: it’s a paper loss. The building isn’t actually losing value. You’re just allowed to pretend it is for tax purposes. That phantom expense reduces taxable rental income — often to zero, sometimes below.

Why it matters

From the same video, Ross frames tax advantages using Muhammad Ali’s rope-a-dope: “He would sit on the ropes, kind of lean back and let people miss him… that’s the same thing with tax advantages. You are able to save your energy, save your money so you can go invest it wisely.”

A rental that cash-flows real money but shows a paper loss on the tax return is the goal. You keep the cash and owe nothing on it. That’s the math that makes rentals compound faster than most people realize.

Cost segregation accelerates it. A cost seg study breaks the building into components with shorter recovery periods — five-year items (carpet, cabinets, appliances), 15-year items (landscaping, parking improvements), and the remaining 27.5-year structure. The accelerated buckets shove a big chunk of deductions into early years of ownership.

The 1031 exchange is the other deferral Ross mentions: sell one property, buy another of equal or greater value within the rules, and defer paying capital gains taxes on the sale. “Kicking the can down the road.” Some operators hold forever and never sell, which is the buy-borrow-die strategy — take a cash-out refinance against the appreciated value, spend the loan proceeds (not taxable), let the depreciation keep the income paper-negative.

How it shows up

Depreciation only runs while the property is held as a rental. A flip is inventory, not a capital asset — it doesn’t depreciate. That’s part of why putting a flip put on the shelf as a rental can quietly be the best tax move of the year.

On resale, there’s depreciation recapture: the IRS takes back the accelerated benefit at up to 25% when you sell. The defenses are a 1031 exchange to push it into the next property, or holding indefinitely and letting estate planning handle the recapture.

Related

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