Yes, of course, with the asterisk that the allowable non-cash expenses for a rental property are pretty high, resulting in typically a low net income (and current taxes) as compared to the free cash flow.
You get to deduct the interest portion of the mortgage (but that's a cash expense, so hits free cashflow as well).
Depreciation is the non-cash expense. It's not exactly as simple as this, but you can depreciate a residential building at 1/27.5 per year and commercial at 1/39 per year. That means if you buy a property for $1.5M where the land is worth $418K and the building $1072K, if it's residential, you'll get a reduction of income of $39K/yr if it's residential and $27.5K/yr if it's commercial. That of course decreases your basis in the property by the same amount (making it a timing preference, not a permanent preference).
Thats genuinely incredible. Reminds me of when I looked into accounts at maersk and realised they did a similar thing with their ships. The idea that something could ever depracate all the way to zero but still be on the books as an asset seems broken to me but I'm not a financial guy so I haven't been able to dive into arguments about why it may or may not make sense.
The fundamental idea is "things wear out" and that wearing out is a real cost (albeit a lumpy, non-cash cost).
In your personal life*, your roof gradually wears out. You buy a place and, at some point in the future, you have to replace the roof. If you sell a house with a 30 year old roof, you get paid less for the property than if it had a 30 day old roof on it.
If that roof was on a piece of incoming-generating property, it would seem wrong to say "for 24 years, the roof was perfect and then in the 25th year, it degraded all at once, needing replacement". If you sell the building halfway through the roof's expected life, it seems wrong that you got paid less for the building (because the buyer knows the roof is ~50%) but that you get no credit for that loss in value while it was happening.
Same for Maersk: if they had a freshly commissioned ship and a 20 year old ship with the same original specs, the new one is worth more money to a buyer.
So, the tax system says "for business-use property, we allow depreciation to model that things wear out and become worth less money over time". This is true for your rental house, an airplane, a ship, a laptop, a desk, a chair, etc.
If you have a roof (on a 27.5 year depreciation schedule) that you manage to get 40 years out of, you get to deduct the value of the roof over the first 27.5 years and then get no deduction for the last 12.5 years because your basis in the roof is zero. Likewise, if you only get 20 years and a day out of it, you depreciate it at 1/27.5/yr for the first 20 years and then take all the remaining basis as a deduction on the day you replace it.
* - where house repairs are not deductible, because they're a personal consumption expense.
Thanks for your insight. I can understand why depracation can go down a certain amount (second hand resale market value demonstrated that etc) but going all the way to zero? like even beyond scrap value (for a ship)? It seems that its not uncommon for people to be able to deduct things that far while still demonstrably making income with them elsewhere on the books.
For example a residential property depracated entirely for 1/27.5 its value every year for 27.5 years, but still being rented out after that period. Presumably it can no longer be deducted from tax, but the accounting idea is that the house has degraded to being worthless but is demonstrably not?
The way I think about that part (which is valid) is:
What would I do if someone tasked me to sit down and try to write a universally applicable tax code that closed that "loophole" without introducing a bunch of other waste/complexity/cost of compliance?
I'd probably wrestle with it a while and then say "screw it; let it go to zero; we're going to recapture it upon sale anyway, so given the projected/hopeful lifespan of the government versus the taxpayer, it doesn't really matter; we'll eventually get our money."
If you don't want to take depreciation (for whatever reason), you need to change the facts and circumstances such that depreciation would not be allowable under the facts.
