Yesterday over at my other blog on ActiveRain I authored a post titled How Are Your Current Real Estate Investments Going? To get background for this post it might be wise and go and read that post.
But the gist of the post was that if you’ve owned the same income property in Kansas City for 7 years or longer you are probably no longer maximizing your returns the way you should be. That in fact;
- You are no longer maximizing your leverage
- If you are properly bifurcating your depreciation you have already exhausted your personal property portion (with the exception of new personal property added)
Leverage was discussed there. We’ll talk about your depreciation here.
Bifurcate is just a $10 word for cost segregation. There are actually 4 ways you can segregate your depreciation on your investment property;
- Land (which of course doesn’t depreciate)
- Personal Property (over 5 years)
- Land Improvements (over 15 years)
- Building (over 27.5 years)
Most people are probably only utilizing #1 & #4. They are overlooking (or your accountant is) #2 & #3. But if you are maximizing your depreciation you can see that by year 7 you have already exhausted all your beginning personal property depreciation and 1/2 of your land improvements.
Why is that a big deal? Because if you have broken out your costs you will probably find that personal property depreciation accounts for between 40% – 50% of your yearly depreciation total. At least at first.
Now as you change carpet, appliances, lighting fixtures and the like you can start a new 5 year schedule on those items. But about 1/2 of your beginning depreciation number is now gone. It’s not coming back.
In addition, you are also 25% of the way through your building depreciation. That investment property that used to give you overall returns of 22%-24% is now generating overall returns of 13%-15%. And it will continue to slide down from there. No matter how much your cash flow continues to build. (Well, there might be exceptions that I haven’t seen.)
It could be that you just don’t want to change houses or there are sentimental reasons you don’t want to exchange or you are just happy with the money you have. But if you are still in the growth phase and you are looking to maximize that Retirement Worth Having, you may wish to consider sitting down with knowledgeable investment real estate agent or tax planner and figure out what to do next.