Rental property depreciation is a way for property owners to lower the amount of taxes they have to pay. It can also help them make more money from their rental property and improve their return on investment. Landlords save money on taxes at the end of the year by claiming the depreciation of their rental property. Let’s take a look at rental property depreciation and what you should know about it.
Depreciation is a term used in accounting to describe the decrease in value of an asset over time. Over time, the value of all assets and products, including real estate, decreases. Rental property depreciation means that you can subtract the decrease in value of your property as an expense on your taxes when you own real estate that generates income.
What is Rental Property Depreciation?
Rental property depreciation refers to how quickly real estate investors can decrease the value of their property for tax purposes and claim deductions. The IRS allows rental property owners to subtract a fixed percentage of the property’s cost basis from the taxes owed on the income generated by the property over its useful life. The rental property usually loses value over a period of 27.5 years, decreasing by 3.64% each year.
Depreciation can help real estate investors save a lot of money over the years. It is important to consult a tax professional to understand the strict rules set by the IRS for rental property depreciation and to ensure you receive the full deduction. Before selling your property, it’s important to understand how rental property depreciation recapture works.
Calculate Depreciation on Rental Property
Determine Your Cost Basis
To calculate depreciation, you need to figure out your cost basis first. Depreciation is determined by a percentage of the original cost of the property, not its current market value. Your cost basis is the total amount you paid for the property, including any improvements or qualified closing costs. Additionally, it’s important to note that land does not lose value over time, so when calculating the cost basis, only the value of the home needs to be considered.
Imagine you bought a rental property for $200,000, and the land it is on is worth $40,000. You are also planning to spend an extra $30,000 to renovate it before selling.
Add Any Qualified Closing Costs
Additionally, you can include qualified closing costs in your cost basis. Just a reminder, if you have a higher cost basis, you can depreciate more. So, it’s a good idea to include as many allowable fees as you can.
Calculate Depreciation
To calculate depreciation, you just need to divide your cost basis by the useful life of the property. Let’s take the example mentioned earlier of a property that has a cost basis of $188,000 and divide it by the GDS lifespan of 27.5 years.
The calculation is as follows: 188,000 divided by 27.5 equals $6,836.36. This means that you can subtract an extra $6,836.36 from your taxable income each year for depreciation.
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Real Estate Depreciation Rules in 2024
The IRS has specific rules about which properties can be depreciated and how the deduction can be taken. Otherwise, it would be too simple to exploit this method. Property owners should understand these standard rules.
What Properties Qualify?
First, it’s important to determine if your property is eligible for depreciation. Before you can depreciate a rental property, the IRS has certain conditions that need to be met.
- In order to qualify, you need to be the owner of the property. However, it is not necessary to own 100% of the equity and you can still take advantage of property depreciation even if you have a mortgage.
- In order to use the property, you need to use it for business purposes or as a way to generate income.
- The property must have a clear and measurable lifespan. For example, raw land cannot depreciate because it does not wear out, decay, or become outdated.
- The property must be able to be used for more than one year.
When Does Depreciation Start?
Depreciation starts as soon as the property is prepared and can be rented out. Just keep in mind that this might not be the time when you buy or rent the property.
For example, let’s say you purchase a home on June 1st, but it still requires maintenance. The renovations will be completed on July 15th, when you can list it for sale. You find a tenant fairly quickly, but their lease doesn’t start until August 1st.
How Long Does Depreciation Last?
You can deduct the entire value of the property over a period of 27.5 years, which is about 3.636% per year (100 divided by 27.5). However, the IRS does allow you to depreciate certain improvements at a faster rate than 27.5 years. For example, appliances can be depreciated over a period of five years because they have a shorter useful life. If you need help with taxes, it’s a good idea to talk to a tax professional. Also, consider using a different schedule to keep track of different improvements.