For all of you tax-day procrastinators out there… Let’s talk about rental property depreciation for tax purposes!
We have covered mileage reimbursement tax treatment in an earlier post. Now, let’s get down to more real estate-centric stuff.
Owning rental property can be a good source of income, but it is income and must be reported as such on your taxes. However, you are allowed to deduct expenses incurred in renting the property from your income. One of these expenses is depreciation. Depreciation is wonderful because it is a ‘non-cash’ expense, meaning that no money actually leaves your pocket but you can still record it as an expense.
Property is depreciated using the Modified Accelerated Cost Recovery System (MACRS). Residential rental property can be depreciated over a period of 27.5 years. You may only depreciate the structure itself. Land does not qualify for depreciation. Now, how do you calculate depreciation?
- When was the property ready to be rented? You cannot depreciate a property until the date is ready to be rented.
- Figure the basis of the property. This is the total cost of the property including closing costs, settlement costs, improvements and any legal fees. From that total you will subtract any insurance payments made to cover casualty and theft losses and the value of the land. You can use tax assessed value for the land. This will give you the basis of the property, which is the amount you may depreciate.
- Divide the basis by the recovery period. As mentioned above, for residential property this is 27.5 years. This will determine the amount per year that can be depreciated.
- If your property was only in service for a partial year, divide the annual depreciation amount by 12 and multiply that total by the number of months your property was in service. This will give you the depreciation amount for the partial year. When figuring the partial year, if the property was placed in service after the 1st day of the month you may only take half-month depreciation. Regardless of whether it was placed in service on the 5th of the month or the 25th of the month you may still only depreciate a half-month.
As always, this is not intended as legal or accounting advice but rather as an educational overview. Please consult a tax attorney or CPA (other than me) for further clarification. If you have lots of free time on your hands, check out what the IRS website has to say about depreciating rental properties.
Depreciation is quite possibly the single greatest allowable expense in the tax code for buy-and-hold real estate investors. Make sure you are using it properly to avoid the hassle of dealing with the IRS down the road.
If you have more questions about tax implications for real estate investors, just ask! Remember, I’m not only owner of one of the fastest-growing Orlando property management companies, I’m also a CPA, so I’d be happy to help!