In most businesses, the IRS taxes your net cash annual income. But when you own rental properties, you can shelter (protect) much of your cash flow from taxes by using a noncash tax deduction called depreciation.
Say your apartment building (exclusive of land value) is worth $500,000. Your pretax cash income from that property equals $20,000 per year. But you don't pay taxes on that $20,000 of income. You only pay taxes on $1,950 ($20,000 of income less $18,150 for allowable depreciation).
What happens to that $18,150 deduction for depreciation if, say, your rental property yields only $10,000 a year in pretax cash income? In that situation, you may be able to write off (deduct) that $8,150 ($18,150 depreciation less $10,000 property income) of unused "loss" from the taxable amounts you earn from your other taxable income (wages, business profits, interest, dividends).
Was this article helpful?