Depreciation is the gradual decrease in the value of an asset over time. For rental property owners, calculating depreciation is an essential part of understanding the financial aspects of their investment. **To calculate MM (Modified Accelerated Cost Recovery System, the most common way to calculate depreciation for rental property), follow these steps:**
1. Determine the property’s useful life
The IRS provides guidelines on the useful life of different assets. Residential rental property typically has a useful life of 27.5 years.
2. Separate land value
You cannot depreciate the land itself, so the first step is to estimate the portion of the property’s value that is attributed to the land. Land value can usually be found on the property tax assessment or through a professional appraisal.
3. Calculate the depreciable basis
Subtract the estimated land value from the property’s purchase price to determine the depreciable basis.
4. Determine the depreciation method
The MM depreciation method for residential rental property uses the General Depreciation System (GDS) with a recovery period of 27.5 years.
5. Annual depreciation calculation
Divide the depreciable basis by the recovery period (27.5 years) to calculate the annual depreciation expense.
6. Example Calculation:
Let’s say you purchased a rental property for $300,000 with a land value of $50,000. The depreciable basis would be $250,000 ($300,000 – $50,000). Dividing the depreciable basis by 27.5 years gives you an annual depreciation expense of $9,091 ($250,000 / 27.5).
Frequently Asked Questions
1. Can I depreciate the entire purchase price of my rental property?
No, you cannot depreciate the portion of the purchase price attributed to the land.
2. Can I use a different depreciation method?
Yes, MM is the most commonly used method, but you may be able to use the Alternative Depreciation System (ADS) if your property qualifies.
3. Can I depreciate improvements made to my rental property?
Yes, you can depreciate the value of improvements such as renovations or additions.
4. What if I only owned the rental property for part of the year?
In partial years, you can still claim depreciation for the portion of the year that you owned the property.
5. Is it possible to accelerate depreciation?
Yes, certain improvements or assets may qualify for bonus depreciation or Section 179 expensing, allowing you to deduct more in the first year.
6. Should I consult a tax professional?
While calculating MM depreciation can be done on your own, it’s always advisable to consult a tax professional to ensure accuracy and understand any specific rules or exceptions that apply to your situation.
7. Can I claim depreciation if my rental property is not profitable?
Yes, even if your rental property generates a loss, you can still claim depreciation to offset other income and reduce your overall tax liability.
8. Can I claim depreciation if I rent out a room in my primary residence?
Yes, you can still claim depreciation for the portion of your primary residence that is used for rental purposes.
9. Are there any limitations on claiming depreciation?
Yes, if your income exceeds certain thresholds, you may be subject to the Passive Activity Loss (PAL) rules, which limit the amount of rental losses you can deduct.
10. Can I deduct depreciation if I use my rental property for personal use as well?
If you use your rental property for personal use too, such as for vacations, you can only claim depreciation for the portion of time it is rented out.
11. Do I need to calculate depreciation every year?
Once you have calculated the depreciable basis and determined the annual depreciation expense, you will need to claim depreciation every year on your tax returns until the property is fully depreciated or sold.
12. Can depreciation reduce my property taxes?
Depreciation does not directly reduce property taxes, as it is a deduction for income tax purposes. However, it can reduce your taxable rental income, which indirectly affects your overall tax liability.