Today's question is very quick and simple. And so I'm going to give a quick, simple answer. And interestingly enough, this is not a question that comes up very often at all. And the reason is, is because the question has to do with something that is 27 and a half years down the road. So John writes in with a question and he says, I've been searching for the strategy planning for approaching end of depreciation, life of rental property. 27.5 years was always so far out there. I didn't expect to still have the property as you get into the twenties, meaning 20 years and on of ownership, not your age of twenties, should you start looking to exchange the property or just disregard and only look at the income potential though, there will be similar units, but at higher-end depreciable cost basis.










So good, good question, John. The answer to the question is really two parts. Really, it depends if you've held a property for 27 and a half years, which by the way, for listeners that are not aware, the IRS allows you to depreciate the improvements of your property, which means everything, but the dirt over a 27 and a half year period, and this depreciation is essentially a phantom write-off. It means you can deduct it from your taxes, your income, your passive income each and every year. And it lowers the taxable income from your property. Now, although it's not actually lowering the income in dollar terms, it just looks like it's lower on paper. So you don't have to pay tax on that. What it is doing is it's giving you essentially a free write off to lower the tax impact, or probably even eliminate the tax impact from the income coming from that property for 27 and a half years.
It's a beautiful thing. It's a powerful thing. It's a great thing that the IRS or the tax code allows us property investors, real estate investors to do with our income properties. It's a beautiful thing. Now what happens is after 27 and a half years, the depreciation has gone. You've effectively written off the entire property, the improvements, and now going forward, you continue to get the cashflow. You continue to benefit from the property. Nothing really changes other than the fact that you lose this depreciation tax write-off. So you have two choices. One, you sell the property well more specifically, you wouldn't just sell it for the sake of selling it. You would sell it under a 1031 exchange, meaning you can sell it and have a tax-deferred exchange and use that equity in the property to buy more that you could leverage. You could finance. You don't have to, but generally speaking, you're going to build up or leverage up from that initial property. And what that does is it gets rid of the old property, but it allows you to step up or move up into more properties, probably increasing your cash flow and you don't lose any equity because all you're doing is moving equity from that first property that you were depreciating for 27 and a half years into two or more properties elsewhere or in the same market. And now you start the clock all over again. You now start that 27.5-year clock on depreciation, right from the beginning. And now you have those phantom deductions once again, but this time probably multiple properties and you have the multiple income streams.
That's generally speaking. Each individual situation is different. And you need to certainly talk to your tax advisor about what makes the most sense, but conceptually and fundamentally, it really comes down to a, do you need that tax write off? Do you need the depreciation or are you happy with the portfolio of properties that you've built that you now have that has given you a passive income stream? Because you've been investing for however long, 10 years or more. I mean, if you've got the property for 27 and a half years, you've clearly started a long time ago and you probably have a lot of property under your belt and you have a good passive income stream.