Since it's tax time, I wanted to give you a simple explanation for what may seem like a complicated topic. Depreciation is the IRS's definition for real estate incurring wear and tear as time goes on; in fact, for tax purposes, the IRS allows you to assume that your real estate will be totally worn down and useless after 27.5 years for residential investment property. Here's how you calculate depreciation:
If you buy a home for $100,000, subtract out the value for the land since even the IRS knows that dirt doesn't wear out. A liberal valuation for land would be 10% of the purchase price. So $100,000 - $10,000 = $90,000. So we're depreciating $90,000 over 27.5 years, this would be as follows: $90,000 / 27.5 years = $3,272 / year. This amount you can write off as a deduction against the cashflow of your home, essentially allowing that income to be tax-free. So if you have a home and you earn $200 / month positive cashflow, or $2,400 per year, you can not pay tax because you have $2,400 in income, with a loss of $3,272 in wear and tear. So $2,400 - $3,272 = -$872. Guess what? You can now take the remainder of this "loss" against your personal earned income from you JOB! So now you just sheltered $2400 in rental income, plus $872 in earned income, and you didn't even have to spend the $3,272 to get the write-off because depreciation is a NON-CASH EXPENSE!!!
Now imagine if you had 5 homes depreciating at $3,000 per year...imagine if you had 20? Would you pay any income tax on your earned income? Would the government actually have to write YOU a check in your depreciation exceeded your earned income!?