Real estate profit center #3: Depreciation
Depreciation is another form of phantom income, but it is also often referred to as a phantom return. The basic concept of depreciation is that your investment property is made up of two parts, the land and the improvements on the land, i.e., your house. Appraisers will assign percentage values to your property based on these two parts. For this example, 20% of the value is the land and 80% of the value is the improvement. Over time, the house will deteriorate, so the government in the US (check with your tax advisor to make sure you qualify), lets you write down that 80% value over a certain number of years depending on the type of real estate. For residential homes, it's 27.5 years. So, your $144,000 property has $115,200 ($144,000 x 80%) that can be depreciated over 27.5 years, which equals $4,189 ($115,200/27.5) per year. This amount is listed as a loss of income, even though no money is coming out of your pocket. Now, let's see why this is called phantom income. Let's assume you are in a 30% tax bracket. That means that applying 30% to your depreciation of $4,189, nets you $1,256.70 ($4,189 x 30%) in annual tax savings. Adding that $1,256.70 to our existing income of $6,765.54 we now have $8,022.24 ($8,022.24/$36,000), a 22.3% return on your cash of $36,000.
Let's take a look at the last profit center, appreciation.
Real estate profit center #4: Appreciation
Appreciation is the phantom income frosting on your cake. I
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