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The Depreciation Factor!

UTCVenturesLtd

UTCVenturesLtd

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I have spent a lot of time actually working on real estate projects and now have decided to do my own bookeeping and better learn that area. The first thing that i noticed as i loaded my company file into the new 2010 Quickbooks Pro software (psst... on sale now at Staples, $50 off til the end of the month) was everything getting depreciated by the accountant. Work done on the properties, the properties themselves, computer, etc.

My stepdaughter bought a new car with a loan. Her car has "depreciated" much faster than her loan she realizes so she loses around $4000 as her bottom line if she were to sell the car.

So can someone elaborate on this area?
What does the depreciation factor actually do for or against the bottom line of a company?
Does this just accumulate til i sell a property and then become a big deduction writing off all the profits at some point?
Is there a magic formula or strategy to use to "benefit" from this depreciation factor like holding property for 5 yrs? 10yrs?
 
Depreciation is also called CCA (capital cost allowance).

It may be used to reduce taxes using a prescribed rate, up to 4% for real estate (i.e. depreciate to 0 in 25 years) for the building, 10% for chattels (i.e. depreciate in 10 years), 30%/year for PCs ... etc. ..

Then there are the new IFRS (International Financial Reporting Standards) rules coming into effect next year which allows you to state real estate TRUE value in your books, as often as asset is depreciated 40% after 10 years of ownership, but in real life it may be worth 100% more. IFRS will rectify this.

more on CCA: For some areas there is room for discretion .. in others there are hard rules set by CRA. Most accountants would know this.

For cars I do not know. I believe you can either write-off the lease up to X/month (I believe it is $600) or yo can deduct XX cents per km driven (around 42 cents I believe).

A car is not an asset. It is a liability. It costs you money every month and it depreciates ! I believe you can`t even put it as an asset on your books (but I don`t know and some accountants may weigh in here with a view !!)
 
I think this is the single hardest thing to understand about this whole business...those dang accountants have to make simple things harder I guess. I am still working on getting the full picture, without actually having to become an accountant myself. I believe that they also call this "Amortization Expense" and of interest, this is why the accountant always wants to know the breakdown of the property value versus the land value. (you cant deprecieate land) also real estate can only be depreciated 2% in the first year (I think) then 4% after.

So, depreciation is a good thing right? It is sort of an invisible expense. Makes your bottom line look terrible though. (smile) I will be watching this thread hoping to learn more.

AWESOME questions...I hope an actual accountant chimes in and talks in a language I can understand!
 
QUOTE (Nukav @ Oct 16 2009, 04:08 PM) Thomas, if you paid cash for the car, wouldnt it then be an asset?

As someone who has a quote from Robert Kiyosaki as their signature, I am shocked you would suggest that.
 
"As someone who has a quote from Robert Kiyosaki as their signature, I am shocked you would suggest that."

Maybe you dont argue with your accountant as much as I do. (smile) but I would say that the definition of an asset is TOTALLY differant depending on who`s perspective you are getting! (and what is used for) Just a thought. cheers.
 
QUOTE (Nukav @ Oct 16 2009, 02:30 PM) "As someone who has a quote from Robert Kiyosaki as their signature, I am shocked you would suggest that."
Maybe you dont argue with your accountant as much as I do. (smile) but I would say that the definition of an asset is TOTALLY differant depending on who`s perspective you are getting! (and what is used for) Just a thought. cheers.

Depreciation is a very important tax tool for the real estate investor with equity in his/her property.
As mentioned before depreciation is only regarding buildings and equipment NOT on land. Land does not depreciate in fact as most of us know, it tends to appreciate.

Depreciation basically means that something is being used up or consumed. Like the earlier mentioned car lease; this is basically a `pay as you go system`. You pay that portion of the car that you used up. The car company uses an estimate how much that is, some leases therefor only allow you to drive a certain number of kilomaters per year. If you drive more, you wear out the car more than anticipated by the leasing company.

The same is true for buildings. Typically, a building has a useful life of between 25 and 30 years depending on its type and use. Of course, you can augment the life when you maintain or renovate the building. So suppose you have a $100,000 building and a useful estimated life of 50 yrs, then the building depreciates or consumes $100,000/50 is $2,000 per year. So after one year the building`s depreciated value is 100,000-$2000 = $98,000 and after 10 years your building`s depreciated value is $100,000 - 10*2000 = $80,000 Got it this far?

So after 10 yrs we do a major reno for $10,000. Now we have depreciated the building down to $80,000 but we also added $10,000 in improvements and thus the new depreciated value is $80,000 plus $10,000 = $90,000. You have also extended the useful life of your building thanks to the reno. Say by 5 years. So now your new annual depreciation is $90,000/(50-10yrs+5yrs)= $90,000/45yrs = $2000 per year. (Oops, this just happen to be the exact same amount as before the reno - that is just coincidence).

Your accountant knows the official percentages for depreciation that is allowed by Revenue Canada. Eh, you may say, what has depreciation to do with taxes? You bet that it is important for your taxes, because it makes having positive cashflow extremely attractive. Much more attractive than interest on an RRSP or a dividend from a stock or a company (except when you are investing within an RRSP or TFSA because there you don`t pay taxes on positive cashflow).

But outside RRSPs you pay do pay taxes on your net rental income or positive cashflow. DEPRECIATION CAN ONLY BE USED WHEN YOU HAVE POSITIVE CASHFLOW - if you have negative cashflow the depreciation is basically `deferred`!

If depreciation is the value decrease due to the use of your building then it is obviously an ... EXPENSE. So if you make a profit after deducting all your operational, financing and propery tax expenses, then rather than paying taxes equalling your marginal tax rate times your positive cashflow, you can use ONE MORE EXPENSE to reduce your rental income sometimes all the way to zero - YES DEPRECIATION MAKES RENTAL INCOME TAXFREE... until you have completely depreciated your building.

Some disadvantages:
1 When you sell the building your cap gains are now a lot more. They are Proceeds of sales minus the Purchase costs PLUS DEPRECIATION DEDUCTED during your time of ownership. This can be quite substantial. BUT you have to realize that first of all, you deferred paying taxes for many years and used this cashflow for new investments (or your BMW).

2 Secondly, you pay less taxes, because when deferred your deferred taxes were based on your marginal tax rate x depreciation. Now you have to pay taxes based on CAPITAL GAINS so... you pay only back marginal tax rate x depreciation DIVIDED BY TWO(2)!!

If you make negative cashflow during a year, i.e. you subsidise your renters, then you CANNOT depreciate the building that year. BUT (and there always is a BUT)... BUT the depreciation value stays the same that year and you can use it once you get positive cashflow.

Finally, it is depreciation that makes building up a large equity position in a property so attractive. Because depreciation makes positive cashflow nearly entirely tax free (remember repayment upon disposal). There is no other form of income that does so!!



I have to run. Hope this helps

P.S. I am NOT an accountant - so if you want to use depreciation talk to your accountant!
 
Depreciation is a method of deferring income tax payable on real estate income and can only be used to reduce the current year income to zero.

Years ago, Murbs were a real estate investment that allowed depreciation to create a loss, thereby giving a high income person a tax deduction (such as a Doctor). This type of investment is now gone. But watch for it in the future.

Depreciation must be recaptured or paid for when you sell the property.

Should be handled by an accountant, as the rules can change quickly, and every person`s situation is different.

Most new investors don`t the basic difference between income and capital gain, let alone depreciation.
 
Hi All,

To summarize: in 99% of the cases capital gain tax < income tax. Therefore, each year maximize your annual depreciation (4%?) in order to reduce your income unless your income is already zero or minus without depreciation. If this is the case, then leave it for the next year (now 8% max, etc.).

In other words, the benefit from depreciation is tax reduction today (income), AND the higher tax saving today (income) than tax payment tomorrow (capital gain) on the same depreciation amount used.

Regards,
Neil
 
Thanks everyone for your replies! I am sure a lot of readers of the forum were wondering about this too or just have not come across it yet.

It seems like you want to buy really great properties using a corporation that lasts forever to hold them in so that they never have to be sold off and take advantage of it.

"Assets" are little donkeys, aren`t they?
I paid "cash" for my Toyota Corolla in 2002. It was worth 50% less 3 years later. and 3 years after that, 50% drop in value again in value!
Cars depreciate unless you buy something like an antique.

I recieved this response in an email from my nephew...

"Regarding the depreciation. It can be good to use it, or it can be bad...it all depends on how long you plan to hold a property. Most people that plan on owning a property for a long time will claim it, while others that will own it for a short time will not claim it.
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In a nutshell, the government allows you to take a yearly depreciation "expense" because, in theory, every year you own your property, it`s useful life is wearing out. The only problem with this is that if you claim depreciation (or a "wearing out" expense), and then sell your property...you have to pay what is called a recapture tax. Basically, this means you pay back the government the amount you saved in taxes each year by claiming depreciation. As a simplified example, if you reduced your taxes by $1,000 each year by claiming depreciation...then you have to pay back the government the Recapture tax, which woul equal $1,000 per year multiplied by the number of years you claimed it. So in this case, somebody owning it for 5 years, would pay the government $1,000 x 5 = $5,000 in recapture tax.

Whereas, if you don`t claim depreciation, you pay more in taxes each year...but then you don`t have to pay this tax at the end when you sell.

On the other hand, somebody who never sells their property, will benefit from depreciation because they`re essentially deferring $1,000 in taxes each year, and if they don`t sell, they never have to pay that back to the government."
 
QUOTE (UTCVenturesLtd @ Oct 16 2009, 06:32 PM) ...Whereas, if you don`t claim depreciation, you pay more in taxes each year...but then you don`t have to pay this tax at the end when you sell.
...
On the other hand, somebody who never sells their property, will benefit from depreciation because they`re essentially deferring $1,000 in taxes each year, and if they don`t sell, they never have to pay that back to the government."
not quite .. allow me two comments:

1) better to pay taxes LATER than the same amount earlier !!

2) Everyone eventually sells as at your eventual death assets (be they buildings or shares of the corporation that owns the piece of real estate) get taxed when they get passed on to your estate !
 
QUOTE (thomasbeyer2000 @ Oct 16 2009, 07:39 PM) not quite .. allow me two comments:

1) better to pay taxes LATER than the same amount earlier !!

2) Everyone eventually sells as at your eventual death assets (be they buildings or shares of the corporation that owns the piece of real estate) get taxed when they get passed on to your estate !

Good points!
Let me know when you write a book on "How to set up your Real Estate business to be most effective!" I want the first hand signed book when it comes out! I would sure like to see a guide that takes you step by step to create a solid business model and all the things to consider as well. Maybe you could create a special course marketed through REIN? What i see out there is basically bits n` pieces that we collect from here and there. Even the courses out there don`t seem be detailed enough. Maybe they would be $100k each then and that is why they are what they are?
Maybe the full membership in REIN would be the next best thing to the $100k course for a fraction of the price?
 
QUOTE (UTCVenturesLtd @ Oct 16 2009, 07:53 PM) Good points!
Let me know when you write a book on "How to set up your Real Estate business to be most effective!" I want the first hand signed book when it comes out! I would sure like to see a guide that takes you step by step to create a solid business model and all the things to consider as well. Maybe you could create a special course marketed through REIN? What i see out there is basically bits n` pieces that we collect from here and there. Even the courses out there don`t seem be detailed enough. Maybe they would be $100k each then and that is why they are what they are?
Maybe the full membership in REIN would be the next best thing to the $100k course for a fraction of the price?


If you have read Zig Zigler then you must have been reading a lot about sales and investments. And yes it is tough to get a good education on Canadian Real Estate. Regarding books, Don Campbell, REIN&#96;s president, has written several books (available at Chapters for around $25 each). They spell it all out.

In November (weekend of 7 and 8) there is the famous ACRE weekend where Don Campbell and several other real estate experts will show interested members of the public and update REIN members in the art of real estate investing.
Here is the link: http://www.realestateinvestingincanada.com...paign=5canadian

If you like ACRES then you may want to decide to join REIN. I can tell you from experience that this membership has truly its privileges.

Hope this helps.
 
QUOTE (UTCVenturesLtd @ Oct 16 2009, 06:53 PM)
Good points!

Let me know when you write a book on "How to set up your Real Estate business to be most effective!" I want the first hand signed book when it comes out! ... Maybe they would be $100k each then and that is why they are what they are?

Maybe the full membership in REIN would be the next best thing to the $100k course for a fraction of the price?


sure .. send me 100K .. and I will personally deliver the 1st hand signed copy of my book next year !!









But all kidding aside, since "real estate" is such a vast topic and spans centuries of experience and ranges from architecture to design to cement engineering to roof slopes to water vapours to money making techniques to mortgaging to landlording to flipping to pre-builds to vacation homes .. in a variety of property types such as townhouses ? condos with oceanview ? single family homes older than 50 years ? new sub-divisions ? pre-sales ? acreages ? horsefarms ? trailer parks ? office buildings in crappy parts of town ? high end luxury condos with high end finishings ? land with sub-division potential ? strip malls ? defunct shopping centres ? warehouses ? storage facilities ? fixer upper homes ?



ANY of these property types allow you to make money once you know what you are doing. It will take a will to learn even the basics in one of each .. let alone several !!



I am at it now for 6 years full time and 6 or so part-time and have mastered barely the sliver called apartment buildings with some side roads titles "townhouses, condos and single family" .. mainly in W-Canada .. so LOADS TO LEARN AND CONTINOUSLY TO LEARN !



a good read to start are these 8 older posts ..





5 ways to make money http://myreinspace.com/public_forums/General_Discussion/61-3347-5_ways_to_make_money.html



How to get started http://myreinspace.com/public_forums/General_Discussion/61-4391-How_to_get_started_.html



LOC vs. mortgage: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-2302-What_is_better_a_mortgage_or_a_line-of-credit_.html



Are you too levered ?

http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10823-When_are_you_too_levered_.html



50 Year house price view: http://myreinspace.com/rein_members_only/Members-Only_Discussion/81-6621-50_Year_Calgary_House_Price_View.html



More difficult lending environment:



http://myreinspace.com/public_forums/Real_Estate_Discussion/62-6908-More_difficult_lending_environment_.html





50/50 ` is this fair ?

http://myreinspace.com/public_forums/Real_Estate_Discussion/62-2015-5050__is_this_fair_.html



Pro`s and Con`s of creating a company for real estate holding:

http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10292-54272-To_create_a_company_or_not.html#54272
 
Hello,

Godfried gave a very good explanation about depreciation. I just want to clarify some points:

1) Depreciation is kind of "old" accounting term. Nowadays, the accountants go by "Amortization". It is the same thing. You can have different ways to calculate your amortization. However, Revenue Canada only accepts CCA (Capital Cost Allowance). It is the fiscal method. So, you can calculate your depreciation, but when filing your Income Tax Return your accountant must do some adjustments since CRA does not accept the regular amortization, just accepts CCA.

2) When using Amortization to offset your positive cash flow, you need to calculate the taxes benefit according CCA, not amortization. CCA is a very good tool to offset profit in rental properties. If your accountant is using that every year, it is decreasing too much the value of the property and it will affect your capital gains in the future.

3) IFRS is coming in 2011 for public companies. For Canadian Corporations and sole proprietors there is no effect. There are some discussions going on about the general accepted accounting principles, but no conlcusion yet.

4) For cars, it is a little bit more complicated. First who is the owner of the car? Is your personal car that you use for business or the car is owned by the company and you also use for personal purposes? There are different rules depending who is the owner. If the car is leased, you cannot amortized the asset. It is not yours. Your lease installments are deductible.

I hope this helps,
 
Can I get something clarified here??Isn`t the point of recapture is to realize the excess (and not ALL) depreciation (CCA) you`ve claimed over the years? So, just because you`ve claimed 20k of CCA, doesn`t always mean you have to claim 20k as recapture at the time of sale.

Since most buildings depreciate in real life (just look at how BC assessment allocates land/improvement value), isn`t it likely that at the time of sale, your improvement value will be LESS than the value when purchased? And therefore some, if not all, of the CCA claimed will not be recaptured?

"Thus, capital cost allowance will be recaptured when proceeds of a disposition exceed undepreciated capital cost; i.e. when assets in a class have been over-depreciated relative to their disposal value...".

example:

Original Purchase cost of building: 10k
Value of building at time of sale: 8k
value of UCC at time of sale: 7k

Therefore:

Total CCA claimed: 3k
Recapture at time of sale: 1K, (this reflect value allocated to building at time of sale - UCC)

The major assumption is buildings will depreciate over time in real life, maybe not at the CCA rate of 4% per year, thus allowing some CCA claimed not to be recaptured at time of sale.

Am I totally off base here????????????
 
QUOTE (jasont @ Oct 22 2009, 11:25 AM) ...The major assumption is buildings will appreciate over time in real life ..
..

On average, properties APPRECIATE by inflation .. more or less ..

This major oversight is now being corrected with the new IFRS (International Financial Reporting Standards) which by 2011 will allow long time asset owners like banks or REIN members show assets at REAL MARKET VALUE .. many a bank owns assets worth billions in prime downtown location that show as 0 on their books !
 
QUOTE (thomasbeyer2000 @ Oct 22 2009, 11:58 AM) On average, properties APPRECIATE by inflation .. more or less ..

This major oversight is now being corrected with the new IFRS (International Financial Reporting Standards) which by 2011 will allow long time asset owners like banks or REIN members show assets at REAL MARKET VALUE .. many a bank owns assets worth billions in prime downtown location that show as 0 on their books !

Sorry, Thomas...I edited my post, I actually wanted to say that buildings do DEPRECIATE over time.

For example, a 40 yr old house will have a lower value than a 20 yr old house of similar specs.

So with that reasoning, I`m saying that depreciation (especially when new) will occur at a faster rate than inflation. I don`t think your building value when you sell will be worth as much as when you originally bought it. Though, I`m basing it on single family homes.
 
QUOTE (jasont @ Oct 22 2009, 12:31 PM) Sorry, Thomas...I edited my post, I actually wanted to say that buildings do DEPRECIATE over time.

For example, a 40 yr old house will have a lower value than a 20 yr old house of similar specs.

So with that reasoning, I`m saying that depreciation (especially when new) will occur at a faster rate than inflation. I don`t think your building value when you sell will be worth as much as when you originally bought it. Though, I`m basing it on single family homes.
yes .. but you have to compare an 20 year old house today to one 20 years old let`s say 10 or 12 or 45 years ago .. it was LOWER .. a lot lower 10 or 12 or 45 years ago .. and it is called: inflation .. a factor not covered well in accounting systems or lingo or rules !
 
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