3 thoughts on “A Simple Look at Depreciation Recapture”

1. Jeff says:

Tax-related question: If cash flow comes out to, say 6-7%, I can understand how overall taxes are reduced through the use of depreciation and accelerated depreciation/cost segregation. But I often read that there generally is NO taxes often in the first 5-7 years due to these depreciation factors. If depreciation comes out to 3.6% (1/27.5) of the multi-family apartments, which is, say, 3% after subtracting out the non-depreciable land, even w/ accelerated depreciation, how does this overcome a full 7% of income the first 5-7 years??

1. PhysicianREI says:

Hi Jeff – Good question. You need to consider what that 6-7% and 3.6% is being multiplied by in order to come up with the numbers to subtract from one another to see what is taxable income. You said cash flow of 6-7% but what I believe you are referring to is 6-7% cash on cash return. In that case, say 6% of whatever cash you put down on the property (CoC return). For an example, let’s say you bought a \$200,000 property with 25% down (\$50,000) of which \$125,000 is depreciable. Say your cash flow ends up being \$3,000 for the year which is 6% CoC. Note you are multiplying that percentage by your amount of cash in the deal. Your depreciation amount would be \$125,000/27.5 = \$4,545. From there you can see how you come up with a loss when you subtract \$4,545 from \$3,000. You aren’t multiplying the percentages you referenced by the same amount, so that is what makes the difference. However, it is worth pointing out that this effect will be less as you decrease the leverage on the property (i.e. increase your cash flow) as at some point your cash flow might exceed your depreciation expense at which point you would then have taxable income.

Hopefully that helped!? If not, happy to illustrate further.