Real Estate Q&A: Should You Buy Young and How Do You Calculate Rental Depreciation?

Zillow real estate investment writer and long-term investor Leonard Baron, MBA, is answering questions from MintLife readers. If you have a question about investment properties, cash flows, insurance, mortgage financing, homeowners associations, renting versus owning, foreclosures and more, drop Leonard an email.

Buying Young

Jacquelyn of La Jolla, CA asks:

I’m 29 and have saved about $100,000 to buy a house, but I don’t really like the ones I can afford. I have a good job as a nurse and am building my savings so that in a few years I will have enough to buy what I would like. My parents are pushing me to buy something now to start building equity and then trade up in a few years. I’m hesitant to do anything at this point. Any advice?

Answer: I think you are doing the right thing by being hesitant. First, you should only buy properties that you love, or at least really like. Buying a property you don’t really like is not a good idea. You’ll probably end up selling it in a few years and losing money.

As for trading up after earning equity, you really need to own a property at least five years, if not 10, to earn a fair amount of equity. The big issue is transaction costs at the time of sale, which can easily run 15 percent of your sales price; thus wiping out all the equity you’ve earned in the first years of ownership.

Your best bet is to save your money to accumulate a substantial down payment. As you are saving for a couple of years, you should be researching areas, learning about home ownership, and finding the places and property types – condo, town home, house – that would best suit you. Additionally, make sure you keep your debt levels low and never miss any payments on bills, so you have a great credit score.

By the way, GREAT job with the savings you already have and keep up the good work!

Calculating Depreciation

Marlo of Las Vegas, NV asks:

I bought a property in 2005 for $300,000 that I used for my primary residence. In 2009, I moved out and rented it. At that time, the home was only worth $150,000. I calculated my annual depreciation based on 50 percent building costs for my $300,000 purchase price divided by 27.5 years. I have used that figure for five years now, but my new accountant is saying my depreciation should have been based on the market value of $150,000, not the $300,000 purchase price. Does this sound right?

Answer: Unfortunately, your accountant is probably right. If your house is worth less when converted to a rental property than when you originally bought it, you are supposed to use the lower market value to calculate depreciation. This is a real zinger for people who already lost a lot of money on their property purchases. In your case, not only did you lose money – you lost the right to maximize your depreciation amount based on how much you paid for the property.

Have your accountant explain the rules to you. Double check your value at the time of conversion and make sure you have the right split between land and building.

Leonard Baron, MBA, CPA, is Zillow’s real estate investment writer, a San Diego University lecturer and real estate due diligence expert. As America’s Real Estate Professor®, his unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions.

Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.