How To Depreciate Rental Property

Because rental property is considered a business, it must depreciated like a business depreciates assets. Sometimes assets can have an accelerated depreciation, but that's not the case with rental property. Owners are required to follow a specific schedule of depreciation for tax purposes and if that schedule is not followed, then there could be legal complications.

What Rental Properties Can Be Depreciated?

You will be able to depreciate property if it meets these specific stipulations.

1. You are the owner of the property that is being depreciated.
2. You are using the property as part of your business, which means you're renting it to tenants.
3. There is a useable life of the property that can be determined.
4. The property will still exist 12 months from today.

What gets many rental property owners in trouble is that they attempt to deduct the full cost of their investment when tax season rolls around. The land that the rental property sits on does not depreciate, however, and so too much of a credit is taken. You can only depreciate the structures and additions to the land that have been added.

How Much Does the Rental Property Depreciate?

For most properties, you're going to receive a depreciation that is 1/27.5 of the total investment that you've made. This means that after 27.5 years, you will no longer be able to claim a deduction for depreciation on the property.

This schedule applies to the functional life of the rental property. This is where things tend to get a bit complicated because certain aspects of your property can depreciate on different schedules. Let's say you purchased a new property and then 12 months later, you bought a new roof. The expected life of the roof is 20 years. Now you'll be depreciating your initial investment at 1/27.5 and the cost of your roof will depreciate at 1/20.

Now let's say the next year you decided to add new carpet to your home. It needed it, so many owners consider it a repair, but new carpet adds value to the property and that requires you to depreciate it. The average lifespan of carpet is about 10 years, so now you'll have the property cost at 1/27.5, the roof at 1/20, and the carpet at 1/10 to depreciate all at the same time. Then, once the property has fully depreciated, it can no longer be claimed.

Note: If you transitioned a property component to personal use, then you can no longer claim any depreciation.

What System of Depreciation Is Used?

Most property owners are going to be using the Modified Accelerated Cost Recovery System for their depreciation deductions on their taxes. If the property was placed into service before 1987 and it hasn't fully recovered its cost, then the Accelerated Cost Recovery System is used. Properties with deductions starting before 1981 use declining balance, straight line methods.

Calculate your costs, figure out what your investments were, and then deduct them properly on your taxes each year to get the proper deduction. In doing so, you'll be able to eventually recover your entire investment cost.
Posted on Oct 16, 2014


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