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Bonus Depreciation on Rental Property

Many rental property owners know about depreciation. Every year, anything of value that is used for business purposes, such as a house that is being rented, can be depreciated so that the investment can be returned eventually each year at tax time. For years prior to 2014, bonus depreciation is the taking of anything of value that was added to your property in a fully depreciated state right away. Instead of deducting an item over the course of 7 years, you'd take the fully depreciation value in one tax year.

What Are the Rules for Bonus Depreciation?

The actual amount of bonus depreciation that you're allowed to take on any given item or in total varies every year. In the years prior to 2013, the expensing annual amount has been $500k and there has been a $2 million limit on investments in place. In 2014 and beyond, those figures are expected to drop to $25k and $200k respectively as the economy has recovered from the Great Recession of 2008.

This means it is more important than ever to determine if bonus depreciation is the right choice to make in the coming year. Here are a few points to consider as you begin to prepare your finances.

Is your property used or is it new? If you are claiming a bonus depreciation, it can only be used for new property. This means that most rental homes do not qualify because they are not brand new. Even if something is new to you, it is still considered used and must be depreciated over time instead of all at once.

Did you receive the rental property in a like-kind exchange? If you exchanged property to receive brand new property, then you can only claim the bonus depreciation on the added value that you've received with the new property. If you had $1,000 in depreciation already claimed in equipment and you traded that old equipment in for new equipment worth $1,500, your bonus depreciation would be just $500.

Are you expecting an operating loss this year? Bonus depreciation is not limited to your taxable income like standard depreciation is. This means you can deduct any amount and then carry that loss back to offset income from the previous year. You can also carry any unused losses that you have this year to next year so future income can be deducted.

Is your rental business passive or active? Bonus depreciation can only be claimed when you are an active participant in your business. It can be claimed for assets that you need to use, such as a vehicle to support your rental activities, but only if you spend a majority of your time in that business.

What Is the Issue of Bonus Depreciation?

The reason why bonus depreciation might not be the best deduction to take is that you may need to recapture the amount that has been deducted if you sell the item. This recapture will reduce the amount of the sale that you receive and increase your tax liability. That is because you are not allowed to deduct $1,000 so that your total value is $0, but then sell the item for $850 the next year. You may need to recapture the depreciation difference.

If you are looking to limit your long-term tax liability and experience short-term savings, then bonus depreciation is a viable deduction to take on certain rental property items. If you have any questions about what form of depreciation is right for you, be sure to speak with your tax advisor to discuss all of your unique options.
Posted on Oct 21, 2014


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