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What Is Rental Property Depreciation?

 

Rental property depreciation can help you deduct property-related costs to lower your taxable income for the year. Tax professionals typically help in calculating depreciation for your properties, but there are benefits to knowing what rental property depreciation is and what to keep track of as a landlord.

Here’s everything you need to know about rental property depreciation and how to calculate depreciation for your properties.

What Is Rental Property Depreciation?

Rental property depreciation describes a property’s reduction in value due to wear and tear or property damage. Depreciation can help landlords recover the costs associated with income-producing properties (such as buying, improving, and managing costs) and must be taken over the expected life of the property.

How Does Rental Property Depreciation Work?

According to the Internal Revenue Service (IRS), you can begin to depreciate your property once it’s ready to rent and available to tenants. Depreciation ends once you’ve fully recovered your costs or when the property is no longer a rental, whichever comes first.

An example of rental property depreciation is as follows: You purchased a rental property on June 20 and published a rental listing for the rental property on August 15. You’ve completed the tenant screening process and found your next tenant set to move in by September 1. Depreciation on the property would begin in August, since your property was ready to be leased in that month.

Rental property depreciation can continue even if the property is not in use, whether it be to make extensive repairs or during the process of finding a new tenant. There are different depreciation methods to follow, but this is often determined by a certified tax professional when completing your taxes.

Can Your Rental Property Be Depreciated?

Your rental property must meet the following requirements set by the IRS to qualify for rental property depreciation:

  • You must be the owner of the property
  • The property must be used to generate income
  • You must be able to determine useful life for the property that’s more than one year

If you’re unsure if your property qualifies, you can refer to a certified tax professional to help answer your questions.

How to Calculate Depreciation on a Rental Property

To calculate depreciation on a rental property, you’ll need the cost basis of the property, the recovery period, and recommended depreciation method. Rental properties placed in service (or in use) after 1986 can follow the Modified Accelerated Cost Recovery System (MACRS) method that spreads costs over the span of 27.5 years — the useful life of a rental property, according to the IRS.

Ideally, a certified tax professional would help you calculate depreciation on a rental property to ensure your tax forms are filled out correctly. However, here are three steps to take to help you perform the calculation yourself.

  1. Determine the cost basis of your property: The basis of the property is the total acquisition cost, including the mortgage, legal fees, transfer taxes, and title insurance. This number is then subtracted from the value of the land the property is built on.
  2. Separate the cost of land and buildings: You can only depreciate the cost of the building, not including the land. To separate the cost between the two, you can refer to the property’s fair market value for individual costs.
  3. Use a property depreciation calculator: Use a property depreciation calculator to determine the cost basis, recovery period, and place in the service period for your property.

The depreciation you calculated can then be shared with a tax professional to confirm the amount is correct.

How Much Does Depreciation Reduce Tax Liability?

You can report your rental income and expenses for your rentals on a 1040 tax form. The depreciation amount will need to be outlined on the appropriate line of Schedule E to reduce your tax liability for the year. Tax liability reduction will depend on the tax bracket you’re in and how much depreciation you report.

 

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