You are probably familiar with depreciation (loss of value over time) from filing past tax returns. Depreciation is used to claim an expense for an item over a number of years, rather than all at once. The number of years used depends on the type of item involved. Real-estate agents and other businesspeople typically use depreciation methods to claim allowable expenses for automobiles, computer equipment, cameras, and other items required to perform their jobs.

Each type of equipment depreciates at a different rate. Some items are considered to have a useful life of five years. That means that one-fifth of the item's value is allowed as an expense during a calendar year. If the item is purchased mid year, the amount you can claim as an expense is based on the months and days it was owned, not the entire year.

Real estate can be depreciated too — not the land, but improvements to the land. The IRS has set a time of 27.5 years as the useful life for structures, so each year you are allowed a depreciation deduction of 1/27.5 of a structure's value.

Depreciation is a paperwork figure only, and it's often enough to make an income-producing property appear to be losing money, even though its cash flow exceeds other annual expenses. Your real estate probably isn't losing value at the depreciated rate — it's more likely increasing in value, but in time, the structure will indeed need significant work or it will eventually fall down. Depreciation allowances help offset those costs.