Depreciation is a balance between current deductions and capital gains.
Depreciation is an important concept for investors. The cost of income producing property is recovered through depreciation, a non-cash accounting entry which may produce yearly tax deductions.
According to the Internal Revenue Service, there are three basic factors that determine how much depreciation you can deduct. They are:
- Your basis in the property,
- The recovery period for the property, and
- The depreciation method used.
You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.
You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces the yearly income tax paid by the investor by reducing the reportable net income. However, depreciation also increases the capital gains tax paid by the investor upon selling the property by reducing the basis for figuring gain or loss on the sale or exchange.