314. Depreciation 101: How to Use It the Right Way to Save Thousands in Taxes

Summary

Tax Smart Real Estate Investors Podcast Episode 314: Depreciation 101: How to Use It the Right Way to Save Thousands in Taxes
Date: February 25, 2025
Hosts: Tom Wheelwright, Ryan

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Episode Overview

This episode delivers an in-depth, practical breakdown of real estate depreciation—what it is, how it works, and how investors can leverage it to significantly reduce their tax liability. Tom and Ryan not only explain the mechanics and terminology (such as straight-line depreciation, accelerated depreciation, cost segregation, and bonus depreciation), but also discuss real-world strategies, potential pitfalls (like depreciation recapture), and advanced tactics like the “lazy 1031 exchange.” The format is highly educational, candid, and full of real examples from both hosts’ own portfolios.

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Key Topics, Insights & Discussion

1. What Is Depreciation? (01:49–03:57)

• Definition & Purpose: Depreciation reflects the theoretical deterioration of a physical asset (e.g., a building) over time for tax purposes, even as the asset may appreciate in market value.
  • Ryan: “Depreciation conceptually... is essentially an expense from the deterioration of a physical asset. Over time… all things kind of generally physically deteriorate.” (02:16)
• Non-Cash Expense: Depreciation reduces taxable income without impacting actual cash flow, making it a powerful tax reduction tool.
  • Tom Wheelwright: “It reduces your taxable income without necessarily reducing your cash flow. So that’s why it’s such a powerful tool.” (03:57)
• Property Types: 27.5 years for residential, 39 years for commercial; land is not depreciated.

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2. Types of Depreciation (03:57–08:26)

• Straight-Line Depreciation:
  • Residential property: Depreciated over 27.5 years (excluding land).
  • Commercial property: 39-year schedule.
  • Example: $275,000 residential structure means $10,000 depreciation/year.
• Accelerated Depreciation:
  • Shorter lives for components: 5, 7, or 15 years, depending on asset class.
  • Bonus Depreciation: Most potent tool; allows you to write off a large portion of those short-life assets in year one.
    • 2018–2022: 100% bonus, phased down to 40% for 2025.
  • Cost Segregation: An engineering study to break down the building’s value into various timelines (5, 15, 27.5/39 years), enabling aggressive front-loading of tax deductions.
    • Tom: “You generally want to accelerate your depreciation and take more of it up front thanks to the time value of money…” (08:11)

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3. How Cost Segregation, Accelerated & Bonus Depreciation Fit Together (08:26–12:10)

• Clarifying Jargon: Cost segregation tells you what can be accelerated; bonus is a way to do it quickly.
  • Ryan: “A cost segregation study is going to help you determine... how much falls into the 5, 15, 27.5, for example... Once we’ve got the 5 and 15 that has a useful life of less than 20 years, basically at current law they are eligible for bonus depreciation. Bonus depreciation is a form of accelerating depreciation.” (08:26)
• Value Calculation: Is the cost of a cost segregation study worth it? It depends on whether losses will be passive or non-passive. It’s especially valuable if you can use those losses to offset active income (i.e., qualify for Real Estate Professional Status (REPS) or STR loophole).
• Passive Losses and the “Lazy 1031” Strategy:
  • Even if you’re a passive investor, you can use depreciation from a newly acquired property to offset gains from the sale of another (the “lazy 1031”).
    • Ryan: “Passive can offset passive... That’s the idea of the lazy 1031 because we’re using no nonpassive rules here, just offsetting passive gain with passive loss.” (10:18)
  • Example: Ryan himself plans to use this strategy in 2025.

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4. Strategic Uses and Limitations (13:03–16:46)

• Depreciation Can Offset What?
  • Tom: “You’re not really using your depreciation to offset your W2 income. It’s the losses that are generated as a result of depreciation. And like Ryan said, it’s either passive or non-passive.” (13:03)
• When is Acceleration Most Powerful?
  • When you qualify for REPS or STR loophole and can turn losses non-passive.
  • Still some benefit to accelerating depreciation for passive investors, especially to offset gain on sale scenarios.
• Timing and Portfolio Management: Losses can accumulate over years and be triggered when needed—important for multi-year planning.
  • Ryan: “The losses don’t go away whether you accelerated them or not via depreciation… I’ve had to wait because they’ve been suspended, but now I’m going to trigger those losses to come in now.” (14:51)

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5. The “Dark Side” — Depreciation Recapture (16:46–23:26)

• What Happens When You Sell?
  • Depreciation reduces your cost basis. When you sell, the difference between sale price and reduced basis is your true gain, a portion of which is subject to “depreciation recapture”—a tax owed on prior depreciation deductions.
  • Tom: “When you take depreciation… every year that’s going to reduce your cost basis. When you sell your property… your true gain on the sale is not going to be $300,000. That’s your capital gain… but also it’s going to be the amount of depreciation that you’ve taken... subject to depreciation recapture.” (16:46)
• Tax Rates:
  • Section 1245 (5-year property): Ordinary income rates (up to 37%).
  • Section 1250 (15-year property): Also subject to higher rates.
  • Straight-line (27.5/39-year): Max 25% for recapture.
• You Must Take Depreciation:
  • IRS will assume you did and recapture anyway, even if you didn’t.
• Mitigation Strategies: Most commonly 1031 exchange (defer gains and recapture) or passing assets to heirs (step-up in basis).

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6. Advanced Guidance: When is Cost Seg Worth It? (23:26–27:12)

• Tom’s Recap — Cost Segmentation Makes Sense When:
  1. You qualify for REPS (non-passive loss).
  2. Short Term Rental loophole applies (non-passive).
  3. You’re selling another property and can offset capital gain/recapture in the same year (“lazy 1031”).
  4. You have significant passive income to shelter.
• Holding Period Matters: Generally suited for investors who plan to hold for multiple years.
  • Ryan: “If you’re going to hold this for like two, three or more years, then a cost segregation study can be really beneficial… Don’t see this as a quick ‘I’m gonna do this and sell in one year’ unless you’re using a 1031.” (22:19)
• Depreciation Recap: You must take depreciation; recapture can be deferred or eliminated (e.g., step-up in basis for heirs).

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Notable Quotes & Memorable Moments

• On the Value of Depreciation:
  • “Depreciation is a non-cash expense that only shows up on paper and has the power to create a loss for tax purposes despite the fact that you might actually be making money.” — Tom Wheelwright (23:26)
• On the “Lazy 1031”:
  • “Passive can offset passive... That’s the idea of the lazy 1031 because we’re using no nonpassive rules here, just offsetting passive gain with passive loss.” — Ryan (10:18)
• On Recapture Reality:
  • “If you don’t take depreciation, the IRS will assume you did and they’ll charge you the depreciation recapture tax anyway.” — Tom Wheelwright (18:22)
• On Timing:
  • “All of this is a timing mechanism. We’re kind of accelerating these things to either the now or… I’ve had to kind of wait to take advantage of these.” — Ryan (14:51)
• Crystal-Clear Summary:
  • “A, you qualify for the real estate professional status… B, you qualify for the short term rental loophole… Or three, when you’re selling a property… those are the three main reasons why you’d want to use it.” — Tom Wheelwright (24:08)

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Essential Timestamps & Segments

• 01:49–03:57: What is depreciation and why does it matter?
• 03:57–08:26: Straight-line vs accelerated depreciation; bonus depreciation explained
• 08:26–12:10: Cost segregation, bonus, and how they fit; “lazy 1031” intro
• 13:03–16:46: Passive vs non-passive losses; when and why to accelerate depreciation
• 16:46–23:26: Depreciation recapture: how it works, tax implications, avoidance and mitigation (1031, step-up)
• 23:26–27:12: Recap of best uses for cost segregation/accelerated depreciation and strategic long-term tax planning

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Takeaways & Guidance

• Depreciation is a fundamental, potent non-cash tax shield for real estate investors; understanding its mechanics and timing is essential for optimizing tax outcomes.
• Accelerated and bonus depreciation, when combined with cost segregation, can offer extraordinary short-term savings — but require thoughtful planning regarding passive vs non-passive treatment and ultimate recapture.
• The “lazy 1031” allows even passive investors to strategically offset gains.
• Always consider exit and recapture strategies early, especially with long-term buy-and-hold intent or generational wealth transfer.
• Cost segregation studies are most impactful when you plan to hold property for more than 2–3 years or have a clear tax situation to optimize.

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Next Steps

• For further learning, consult previous podcast episodes on Real Estate Professional Status (REPS) and Short Term Rental loophole.
• Questions on personal application? Contact the team or join the “Tax Smart Investors Facebook Group” (emails and groups referenced in episode).
• For a tailored tax-saving analysis, schedule a consultation via www.therealestatecpa.com/podcast.

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This episode is a must-listen (or read!) for any property investor looking to boost returns by getting smart on depreciation, with practical, actionable guidance—minus the jargon.

Transcript

[Tom Wheelwright]

You're now listening to the Tax Smart REI Podcast, the number one tax podcast.

For real estate investors.

[Podcast Host/Producer]

Your source for all things real estate accounting and tax. Here we reveal our secrets that can save you thousands in taxes, streamline your accounting process, and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business and how they steer clear of Uncle Sam.

[Tom Wheelwright]

Hey, welcome to this week's episode of.

The Tax Smart REI Podcast. Today we're going to be doing a depreciation deep dive. So we know depreciation is everybody's favorite topic because it's such a tax savings tool. So when we talk about cost segregation, studies, what depreciation is, how it works, depreciation recapture, how to avoid it, and so much more. If you're interested in reducing your taxes by using real estate, this episode's for you. We'll be diving into all that in just one minute.

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We'll see you over there.

But right now we'll jump right into today's episode.

We're back. And Ryan, today we're talking about everybody's favorite topic, depreciation, what it is, how it works, strategies, the whole nine. If you're new to the show, this is going to be an eye opener for you. If you're a longtime listener, it's going to be a great refresher. Probably going to learn some new things. Might even just remind you some things that you already know. First things first, what is depreciation? Why are we even going to be talking about on today's episode? Ryan, do you mind just taking that away with what exactly is depreciation?

[Ryan]

Yeah, depreciation conceptually would be like the intention when we got it from our lawmakers was essentially a expense from the deterioration of a physical asset. Right. Over time you're going to buy say a building for 500,000 and over time that's going to start to deteriorate because it's a physical thing and all things kind of generally physically deteriorate. So basically in 100 years, it's probably still not going to be that exact same material and product that you bought. It's going to deteriorate. And so basically our lawmakers were saying you can get this depreciation deduction because these things are going to kind of slowly deteriorate. I keep using that word, but that's just what's happening. And really it's a capital asset that we're deducting the cost over time. And so basically from the different changes in our law, we've got things like 27 and a half year property or 39 year property, if we're looking at commercial, we've got things like 15 year property, which are land improvements, we've got things like five, seven year property, things like that. All of it is around. How quickly is that going to deteriorate over time? And we've just kind of come up with these general rules of what things are going to take that amount of time. But it's also just a non cash expense.

[Tom Wheelwright]

Right?

[Ryan]

It's a non cash expense where, yes, we paid money upfront for this. Like I said, the $500,000 building, that was our purchase. But again, it's from that capital asset and we're getting that expense that's not, not continuing to be cash, not like we're paying 500,000 and then we're also paying the expense for this depreciation expense. So that's why we call it a non cash expense over time that we get to take advantage of. So there's more there. Tom, did I miss anything there from like a high level overview of depreciation there?

[Tom Wheelwright]

Yeah. No, no, no. Long story short, you know, you did a great job. Just summarize that real quick for everybody who's new. Basically, long story short, depreciation, your building deteriorates over time despite the fact that it might be actually appreciating. But the IRS gives you a depreciation deduction to Track that it's non cash expense. So that means it reduces your taxable income without necessarily reducing your cash flow. So that's why it's such a powerful tool. We use it in combination with strategies like the real estate professional status and the short term rental loophole. We'll be talking about all of that throughout this episode. But basically it's a significant tax reduction tool. And if you're investing in real estate, you need to understand how depreciation works so that you can use it to your advantage. So kind of like Ryan mentioned before, there's different types of depreciation. There's straight line depreciation and then there's accelerated depreciation with straight line depreciation. Exactly what it sounds like. When you have a residential property that's going to be depreciated over 27 and a half years, when you have a commercial property like an office building or a retail center, industrial, things like that, that's appreciated over 39 years. Okay? With 27 half year property, you're going to exclude your land value. So something important to understand in this entire conversation is land is never depreciated, only the building and the improvements is what's depreciated. So when you subtract the land value, you can be left with the building that's typically going to be for residential over 27 and a half years. So if you had a property you purchased for $275,000 and that was the building value, let's just say that was the building value, you're going to take $10,000 of depreciation every year. If it was a commercial property, let's just say you bought that for $390,000, you're going to take roughly $10,000 of depreciation each year over 39 years. Very simple. And that's how most properties are going to be depreciated. But there's something called accelerated depreciation, which Ryan kind of referenced before. You have that five year property, you have that 15 year property that's depreciated over shorter periods of life. And those two forms of depreciation, that 5 and 7 year and 15 year property can be accelerated using various types of accelerated depreciation, including double declining balance, which we're not going to go through all the nitty gritty details of double declining balance here, but just know that double declining balance allows you to take more of your depreciation in the earlier years and it kind of tails off in the subsequent years. It has not really been all that popular when 100% bonus depreciation was still in play. But now that we have bonus depreciation at lower percentages, double declining balance is still used a little bit more. That brings me into bonus depreciation, which is the most potent form of accelerated depreciation. And as we know, if you were an investor from basically 2018 through 2022, you were able to fully deduct 100%, deduct your 5, 7 and 15 year property using 100% bonus depreciation. But that since started to phase down. 2023, it was 80%, 2024, 60% this year. Currently in 2025 it's 40%. So it's not as potent as it once was. But many of us do believe that with the new administration, 100% bonus appreciation will make a comeback. We don't know when yet. At this point there's a lot of talk, a lot of speculation, no concrete answers. So stay tuned to the podcast. As soon as we do have information on that, we will be releasing. In fact, we have Nate coming up on a future episode. He's going to help debrief where we are with 2025 tax changes. But just know right now, in 2025 we have 40% bonus depreciation. And you might be asking yourself, well, okay, we have our building is 27 and a half years and or 39 years. How do we find out how much of our building is actually going to be depreciated over 27 and a half or 39 years versus what's eligible for this five, seven to 15 year property, which can be accelerated. And that's just done via cost segregation study. Long story short, Cost segregation study, an engineer comes down to your property and surveys it, breaks down all the various components and gives you a report and says, hey, this amount of Your property is five year old, seven year, 15 year, 27 and a half or 39 years. If it's commercial. That's how it's done. The reason why this is important, just to tie it up and then I'll pass it off to Ryan for how you can actually use this or what this actually means for you is that you generally want to accelerate your depreciation and take more of it up front thanks to the time value of money, right? If you can use this depreciation to help you offset your rental income or if you use like the real estate professional status or short term rental loophole, which we'll talk more about, then this can Help offset your W2 or your active business income for Even additional tax savings.

[Ryan]

Yep. And just to tie something before we move on, Tom, a common just like terms that are out there and people when talk to them, they're just like, I've heard of accelerated depreciation, bonus depreciation, cost segs. I don't really know how they all fit together. So I just wanted to take a minute while we're talking about depreciation, kind of how this all works. So a cost segregation study is going to help you determine of your cost for the purchase of this building land, how much of that falls into, like Tom said, the 5, 15, 27, half, for example. Right. So basically once we've got the 5 and 15 that has a useful life of less than 20 years, they basically at the current law are eligible for bonus depreciation. Bonus depreciation is essentially a form of accelerating depreciation is maybe one way to kind of look at it. So cost segregation study helps us determine what can be accelerated to 5 and 15 and then bonus depreciation is kind of like the type of acceleration that we can get. How quickly. Right. Is it 100%, is it 40%, is it we have to depreciate it over five years, is it over 15 years, that kind of thing. So maybe just some terms there that maybe you've heard on our podcast a lot and just wanted to take a second here to kind of help people like dissect where do they kind of fit in and how do they relate together. Now moving on to just some other things like Tom was mentioning too. So as we think about accelerating depreciation with something like a cost segregation study, then we're starting to determine, okay, is this valuable to me to get a cost segregation study done because it's going to cost money, there's going to be a fee, whether it's more of a do it yourself software option, that's a couple hundred bucks, maybe 750 to you've got a full blown engineering study which could be thousands of dollars, something like that. The value of that additional fee and accelerating the depreciation in a form of tax savings is going to depend partly and largely if you've got passive losses or non passive losses. So passive. You guys have heard us on the episode here talk a lot about real estate in general is passive. And then the non passive is going to be do we meet something like real estate professional status or the short term rental strategy? If we're meeting one of those and we're starting to use non passive losses and the benefit of a cost segregation study and Depreciation as a whole to get that accelerated just becomes that much more valuable. Okay, but it doesn't mean. I just want to highlight this one thing real quick. A lot of people think if my losses are going to be passive, then I cannot take advantage of or it doesn't make sense to do a cost segregation study, period. That is not true because that then leads me into a strategy which you've probably heard called the lazy 1031 exchange. Okay, so the general idea is that if you are, for example, selling a rental property, you've essentially got a passive gain. It's going to come through on your tax return and you got to pay tax on that. Well, passive can offset passive. Right. Passive gain can be offset by passive losses, whether they were suspended in the past or their current year losses. Right. It's all kind of passive. So the idea here is that we can basically find value in doing a cost segregation study even if you have no non passive losses from real estate, if it means that it can offset a passive gain. Okay. Again, oftentimes people call that the lazy 1031 because basically we're using no non passive rules here like real estate professional status or the short term rental loophole to then actually get us some tax savings. And personally, I'm probably going to do this a lot this year. I am in communication with my Realtors to basically sell a bunch of my portfolio and I'm basically planning to do this. I'm not using real estate professional status, I'm not using the short term rental loophole. I'm actually using this strategy probably a lot this year, hopefully. So this is something that's very common if you're looking to sell. Okay, this is usually when this kind of comes up.

[Tom Wheelwright]

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One thing I just want to add, I hear a lot of things out there. I'm on forums or just questions that I get asked is like, can I deduct my depreciation? Can I use my depreciation off of my W2 income or my business income? And the reality is you're not really using your depreciation to offset your W2 income. It's the losses that are generated as a result of depreciation. And like Ryan said, it's either passive or non passive. If it's passive, then it's going to help you offset your rental income or income that you have from other passive activities. Primarily going to be rental income for many people listening to this show, which has benefit, right? Rental income is taxed up to 37% your ordinary income rates. If you're a high income earner and you could shift some of your income into passive income, then depreciation helps you shelter that you're saving money on taxes, right? And then if you have excess losses when you sell a property, it can help you offset, like Ryan said, what he's going to do with his portfolio can help you offset the capital gain. So there's value in it being passive, right? It's just something I want to point out there because a lot of times people think if it's not non passive, there's no benefit. Having said that, if you are on the passive side, it may not always make sense to do a cost segregation study, right? If you're selling your property, probably worth doing a cost segregation study, right? On a prior property or another acquisition that you made maybe in that year to help you offset that capital gain. But where you know it's really quite powerful is when it's non passive. And you can use the short term rental loophole or you can use the real estate professional status to turn losses from your rentals non passive. And we're not going to talk about those two strategies too much here on this episode. Honestly, we have so many episodes about it on it. Just scroll through the feed, you'll. You'll see it. So if you do want to learn how to use the real estate professional test or short term rental pole again, go check out those episodes. We have an entire series on it. Reps and STRs. Basically, there are strategic Ways to use depreciation. And you should definitely be looking into how you could use it.

[Ryan]

Yep. Before we move on, Tom, I just wanted to mention the reason that something like the real estate professional status in the short term rental loophole with a cost segregation study kind of combining these things is because we get the losses now. Right. It's kind of like a timing to like we use the word accelerated. And it's getting the losses now to offset your W2 or business profits, whatever kind of other non passive income you have. But what I'm talking about for like my situation basically I've over time owned real estate since 2017 and I have been passive the whole time. So I have now through not perfect portfolio, you know, growth and cash flow, kind of accumulated a lot of losses over time. And now I'm going to trigger those losses to come in now. Okay. So the detriment to me from a tax perspective is I've had to wait because they've been suspended. Right. So had I been able to now unlock all those losses from maybe I'll use this year in tax year 20, 25 to back in 20, you know, 18, 17, whatever. I was at a different tax bracket then. But the time value of money says if I had gotten all those savings back then, I would have been better off. Right. That's kind of the theory and that's just the way the math works. But all of this is just one that I wanted to comment on. This is basically a timing mechanism. We're kind of accelerating these things to either the now or like. And in my case I've had to kind of wait to take advantage of these. But the losses don't go away whether you accelerated them or not via depreciation. Like Tom said, it's all about the ultimate bottom line loss number that you're kind of getting to use for like the lazy 1031 for example. That's what we're ultimately getting to use as far as passive losses. But again accelerating that depreciation from say I go do a new investment somewhere or even in a syndication. Cool. If I'm getting a huge loss, I can use some of that to offset my passive gain with the 1031 light, or lazy 1031 like we call it. So just want to comment on that before we moved on to help people.

[Tom Wheelwright]

Yeah, yeah. Now we have to move into the dark side of depreciation. There's a dark side. And don't worry, there's a light at the end of this tunnel and we'll talk about that. Too. All right, so when you take depreciation, you're depreciating, like we kind of mentioned before, you're depreciating capital asset. A capital asset is not immediately deducted. You're not buying your property and immediately deducting the entire thing today, this is not how it works, even with 100% bonus depreciation, and it's not the entire thing. So what happens is you have the cost basis and every time that you take a depreciation expense, so every year that's going to reduce your cost basis. And when you sell your property, okay, so say you bought a property for $500,000 and it appreciates $800,000 and you sell it after 10 years. Let's just say 10 years for the sake of argument here, your true gain on the sale is not going to be $300,000. That's going to be your capital gain, okay? And that'll be taxed at capital gains rates, in this case, long term capital gains rates. But also it's going to be the amount of depreciation that you've taken over the years of your properties and reduce your cost basis. So let's just say, for example, to give you an example here, you purchase the property for $500,000 and let's just say you took $200,000 in appreciation over the course that you owned it. And I'm just ballparking these numbers for the sake of example here, okay? Then your cost basis would be $300,000. So when you sell your property for $800,000, okay, your true gain is going to be $500,000, $300,000 of that. Again, it's going to be the capital gain. $200,000 can be subject to depreciation recapture. So depreciation recapture is a tax that you have to pay on the depreciation you've taken over the course of the time you've owned the property. Now, there's different types of depreciation recapture. There's section 1245 recapture, which is depreciation taken on that five year property. Okay? So if you used any type of accelerated depreciation or you just depreciated five year property, you are going to be subject to ordinary income tax rates up to 37% under current law, plus state taxes, so on and so forth on that section 1245 property. Then there's something called 1250 recapture, and that is from accelerated depreciation on section 1250 property, which is land improvements, basically that 15 year property. And then there's going to be depreciation from straight line depreciation, that 27 and a half or a 39 year property. So the 1245 and the 1250 recapture. So those land improvements, that's going to be subject, when you accelerate it, is going to be subject to that ordinary income tax rate. Okay. Whereas the straight line depreciation is going to be subject to a max rate of 25%. Okay? So those are just the tax rates just to be aware of on the depreciation recapture. Now, when we get to this point, we're having the conversation with somebody, a client, potential client, whatever the case is, usually start asking, well, Tom, so wait a second. I'm going to have to depreciate my property and then I want to pay it back in taxes. Why would I do that? Why would I want to depreciate my property at all? Why would I want to accelerate my depreciation? Well, first of all, you have to take depreciation. If you don't take depreciation, the IRS will assume you did and they'll charge you the depreciation recapture tax anyway. Okay. For the depreciation that you either taken or could have taken during that time. So you have to take it. That's a number one. Number two, why would you accelerate that depreciation? Well, we've kind of already addressed it. A lot of times you would consider accelerating the depreciation. So you could take the deductions now, then take the tax savings and use it to reinvest and continue growing your portfolio. And we know with the time value of money, a dollar today is worth more than a dollar tomorrow. So that's why you'd want to do it. But there's also good news, as if you have a long term view on real estate and you take the longer perspective and you're going to be in real estate for decades or perhaps for life. Then there are ways to mitigate this depreciation recapture tax, and that is primarily through the 10:31 exchange. I'm not going to do a tear down here with the 1031 exchange here today, but just know the 1031 exchange when you sell your property allows you to defer your capital gains and depreciation recapture tax when you reinvest the sales proceeds into another investment property. So if you buy a property today, use accelerated depreciation, you're able to offset your W2 income, or maybe you're using it to offset the gain on sale for another property. Whatever the case is, when you sell that property, you can use a 1031 exchange to defer that. And you can continually do that over and over and over again throughout your lifetime. And then when you pass away, your heirs will inherit the property at a step up in basis, essentially resetting your tax basis and eliminating all the capital gains and depreciation recapture tax. So that's how you kind of deal with depreciation recapture. Understand that it's, you have to take depreciation and when it comes to depreciation recapture, it can be mitigated if you're in the game for the long term.

[Ryan]

Yeah. And some people, you know, if you're listening to this and you determine that, hey, real estate isn't my thing, you know, I'm just gonna get out. Okay, like you're just gonna get out, Right. What this works well for is if people know that they're going to like upgrade or they want to get out of specific property and they've got a decent gain, maybe a lot of equity, then great, let's, let's defer that kind of depreciation, recapture capital gain and let's move that into another property. Right. Using a 1031 exchange. For those of you who are just like, I just am going to get out, was this beneficial? Maybe it's going to depend on how long you held that property and kind of that time value of money. But like we're saying this is a long term play. As we think about real estate and getting the accelerated depreciation, this is really who this is going to be most, most beneficial for those who are looking to do that. And like Tom said, this is like the most common way. We're very comfortable with this in helping people walk through that. And yeah, there's the dark side. Absolutely. That maybe we don't talk about enough. We talk about a lot of the benefits and we just wanted to especially take some time to kind of think through some of the latter part when we exit and some strategies there. So don't be caught off guard with this. That's why we're talking about it. There's a ton of benefit, but we do need to think through long term. Should you even do something like we talked about earlier, a cost segregation study? That's why normally if you talk to people in the industry, it's like, if you're going to hold this for like two, three or more years, then a cost segregation study can be really beneficial. Don't see this as like a quick like, hey, I'm going to do this cost segregation study and then sell it for in one year. That's probably not going to make sense to kind of accelerate all that depreciation unless you're going to do something like a 1031 exchange. So I think that's some additional comments I wanted to throw in there as we're thinking about this.

[Tom Wheelwright]

Let's just wrap this up with a quick recap of what we learned here in today's episode about depreciation, one of the most critical expenses and most important expenses for real estate investors. All right, first, depreciation is a non cash expense that only shows up on paper and has the power to create a loss for tax purposes despite the fact that you might actually be making money or you might have positive cash flow in your rental property. So very powerful tool and really what it is to go beyond that. The reason why you get the depreciation expense is because it tracks the deterioration of your property as it falls apart over time, despite the fact again, that your property might actually be increasing in value. Okay, so that's kind of what depreciation is and what the benefit of it is. Now, when it comes to the depreciation, you're going to have straight line depreciation or you're going to have accelerated depreciation. All right? The accelerated depreciation rapidly increases your depreciation expense. And usually in the first year with bonus depreciation, or in the early years when you're using the double declining balance, which is still kind of used today as bonus depreciation begins to phase out. Now, when it comes to accelerated depreciation, it doesn't always make sense to accelerate depreciation. The reason for that is because you have to usually get a cost segregation study performed to be able to get the breakdown of the various components in your property that are eligible for accelerated appreciation, typically 5, 7 and 15 year property. Okay. When it does make sense to actually go ahead and do that, the cost segregation study is usually in one of three circumstances. A, you qualify for the real estate professional status, which allows you to take losses from your long term rental properties as non passive. B, you qualify for the short term rental loophole, which allows you to take loss from your short term rental properties as non passive to offset your W2 and active business income. Or three, when you're selling a property, another property, and you want to use the losses from a property you acquired in the same year or perhaps you already have in your portfolio to use those losses to offset the capital gain and depreciation recapture from the sale for another property. So those are the three main reasons why you'd want to use it. I suppose if you had a lot of passive income from other properties, that could be the fourth reason, although I'd say that's less common that we see that actually play out. But those are the reasons why you would want to accelerate depreciation. Now there's depreciation recapture and that's a tax you have to pay on the amount of depreciation you have taken over the time that you own the property. And you have to take depreciation. So you cannot avoid it. You cannot avoid it. You have to take it. So the way you can mitigate your exposure to depreciation recapture is by using a 1031 exchange to sell your property, buy another one, reinvest the proceeds into another property, or by using the lazy 1031 exchange, which is when you sell one property, you buy another one in the same year. Or you it could be in any order as long as both happen the same year. And then you use it as a cost segregation study and accelerate depreciation, like bonus depreciation to offset the capital gain from the sale of your original property. So that's in a nutshell, what you need to know about depreciation. If you do have questions about depreciation, go ahead and send us an [e-mail] or by joining our Facebook group, the Tax Smart Investors Facebook Group on Facebook. We'll be taking questions from there on our next live Q A episode. So you don't want to miss that. Also, if you do want someone just to help you shortcut this entire process, shortcut the learning curve for you and look at your situation, tell you exactly what you have to do for your situation, how you can use depreciation, how you can use all these other strategies we talk about on the show to help you reduce your taxes. Then you can go ahead and request an initial consultation at www.therealestatecpa.com podcasts and we'll see you over there. That's it for today's episode and we'll catch you on next week's episode of the Taxpayer REI Podcast.

[Podcast Host/Producer]

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