Calculating the reduction in value of a residential investment over its useful life allows for a non-cash deduction on income taxes. This deduction reflects the gradual wear and tear or obsolescence of the property. For example, a residential building’s cost (excluding land) is divided by 27.5 years to determine the annual depreciation expense.
The ability to deduct this expense offers significant financial advantages to rental property owners. It lowers taxable income, resulting in tax savings and improved cash flow. Historically, depreciation accounting methods have evolved to more accurately reflect the economic realities of asset consumption, providing a standardized approach recognized by tax authorities.