When you invest in something as large as real estate, you want to get as much back at tax time as you can. Most people have heard of the main tax write-offs, like mortgage interest, insurance, and repairs. However, one of the most significant deductions for landlords is depreciation. Savvy investors who want to make the most from their rental properties should know what depreciation is and how to properly calculate it. So, if you’re curious about calculating and claiming depreciation at tax time, just keep reading.
What is Rental Property Depreciation?
Rental property depreciation is one of the biggest benefits for investors. Essentially, it allows rental investors to deduct the cost of buying or improving their rental property. However, it’s different from repair and maintenance tax write-offs since depreciation occurs over a period of time, while other deductions happen all at once.
To depreciate a rental property, you must prove that it has a useful and functional life. For example, if a company buys a piece of equipment costing $10,000 and they can expect it to last at least ten years, they can deduct $1,000 each year for ten years.
That said, on average in the United States, a home can be depreciated over the course of 27.5 years at a rate of 3.636%. Overall, depreciation allows capital expenditures to lower a landlord’s taxable income for a period of time.
If you hold your property until the 27.5 year time period is up, depreciation stops. The reason for this is that the building’s useful lifespan for the purposes of rental property depreciation has expired. On the other hand, if you sell your rental property at any time during the 27.5 years to another rental investor, the depreciation resets for another 27.5 years.
Criteria for Claiming Depreciation at Tax Time
When it comes to claiming depreciation at tax time, landlords need to fit specific criteria to qualify. For example, they must be the owner of the property, and the primary use of the property must be for business or earning income. Some other standard criteria include:
- Does the property have a calculable useful lifespan?
- Is the property going to last more than one year?
- Was the property put in service and disposed of within the same year? If so, it wouldn’t qualify.
When Does Depreciation Begin?
When the property is listed for service, that’s when depreciation begins. So, for example, if you own a rental, depreciation would start once you’ve listed the property as ready to rent. That said, you can only depreciate the cost of the building(s), not the cost of the land surrounding it.
How Long Can You Claim Depreciation?
As stated above, depreciation only lasts for a certain amount of time. That said, you can depreciate a rental property until you’ve already deducted the entire cost of the property, you sell the property, or it’s no longer in service as an income-producing property.
Can You Depreciate Home Improvements?
Rental investors can depreciate more than just the cost of the home. Anything that enhances the usefulness or value of the property, like renovations or improvements, can also be depreciated. Some of the most common improvements in a rental home include:
- Building a new garage or other addition
- Repairing or replacing the roofing
- Installing new flooring
- Replacing or adding new heating or cooling systems
It’s important to note that maintenance or routine repairs are not the same as renovations or improvements. You can deduct maintenance costs or more minor repairs within the year they occur. On the other hand, large, necessary improvements are depreciated.
Is Depreciation Different Depending on the Property?
As most investors owners know, not all rental properties are the same. That said, claiming depreciation at tax time is different depending on what type of property you own. For example, if you have a residential property, it depreciates over the course of 27.5 years.
On the other hand, if you own a nonresidential rental property, it depreciates over the course of 39 years. That said, nonresidential properties include those that do not provide living accommodations. Some examples may include offices, retail stores, or warehouses.
Calculating and Claiming Rental Property Depreciation
Calculating rental property depreciation is simple and quite easy if you use the straight-line formula. However, the IRS has a few different ways of calculating depreciation. For example, there is the Accelerated Cost Recovery System (ACRS) and the Modified Accelerated Cost Recovery System (MARCS). But, to keep things simple, for now, we’re going to go over the straight-line formula.
The straight-line formula is fairly simple and easy to calculate once you already have your numbers figured out. For example, to figure out your property’s annual depreciation cost, you need to subtract the land value from the acquisition cost, then divide it by the IRS depreciation period.
Acquisition Cost- All expenses related to purchasing a property make up the acquisition cost, including the purchase price, taxes, and improvements.
Now, let’s go over a quick example:
If you purchased a property for $300,000 and the land value is $25,000, then that means the building value is $275,000. Now, to find out how much you can deduct for depreciation, you need to divide $275,000 by 27.5 years. The result comes out to $10,000, which is how much you can deduct for depreciation each year.
Claiming Depreciation at Tax Time
Now that we’ve gone over the basics of calculating rental property depreciation, you’re probably wondering about the process of claiming depreciation at tax time. Well, it’s actually not too complicated. To claim depreciation on your taxes, you need to fill out IRS Form 4562.
When you report depreciation to the IRS, you need to separate your expenses. For example, you need to report rental income as well as expenses and losses. That said, there are different forms you need to fill out for income, expenses, and depreciation.
Keep in mind that if you own more than one rental property, you need to report depreciation for each property separately. All of the details of calculating and claiming depreciation at tax time can quickly become very overwhelming for rental investors.
Additionally, most real estate investors are not tax experts, so it doesn’t hurt to reach out to tax professionals for help. Some industry professionals who may help you with taxes include Certified Public Accountants (CPAs), Enrolled Agents (EAs), or tax attorneys.
Need Help With Your Rental Property?
Running a rental business can be very stressful for owners with more than one property. That said, when you own multiple rental properties, claiming depreciation at tax time can be time-consuming and somewhat confusing. After all, landlords already have enough to worry about with tending to tenant needs, collecting rent, and making sure the business is running smoothly.
If you find yourself struggling and could use some help managing your rentals, reach out to a trusted management company. Bay Property Management Group has some of the greatest rental management professionals to help with any of your business needs. For example, we can take care of:
- Tenant screening
- Rental registration
- Move-In/ Move out reports
- Maintenance requests
- Rent collection
- Eviction services
- And more
Additionally, we can send you monthly and annual financial statements for each property, so you can track your finances better. If you’re interested in learning more about our property management company in Baltimore, Philadelphia, Washington D.C., Northern Virginia, and other surrounding counties contact us today!