At one time depreciation was used by the wealthy to reduce their sizeable incomes. They would take the loss from their property primarily attributable to depreciation (it occurred only on paper) and deduct it from their ordinary income. That reduced their ordinary income, which, of course, reduced the amount of taxes they would owe on that income. That tax shelter was eliminated for the wealthy by the Tax Reform Act of 1986. Now deducting a loss is only available if your income is less than $150,000. The maximum deduction is $25,000 and you lose 50 cents for every dollar of that for income you make over $100,000, up to $150,000. However, in order to qualify you need to take an active part in the management of the property. See a good accountant on this one.

It’s very important that you keep every receipt and note every expense and piece of income in a ledger. At some time you may have to prove to the IRS that the expenses you have reported on your investment property were real.

For example, three years earlier you had a water heater go out and you spent $500 getting it replaced. “Prove it,” says the IRS. So, you reach into your bag of receipts and pull out an invoice from the local plumber listing time and materials, including a new water heater for $500. That’s very hard to dispute.