Investing in real estate can provide various financial benefits, including tax deductions. One of the most valuable deductions available to rental property owners is depreciation. Depreciation allows you to recover the cost of an income-generating property over time. Here’s how you can write off depreciation on a rental property and maximize your tax savings.
Understanding Depreciation
Depreciation is an accounting method that allows you to allocate the cost of an asset, such as a rental property, over its useful life. It acknowledges the fact that assets tend to lose value over time due to wear and tear, deterioration, or obsolescence. Although real estate often appreciates in value, the IRS allows property owners to claim depreciation as an annual deduction.
Method of Depreciation
The most common method of depreciation used for rental properties is called the Modified Accelerated Cost Recovery System (MACRS). This method assigns a specific number of years over which the property can be depreciated, depending on its classification.
How to Calculate Depreciation
To calculate depreciation, you need to determine the cost basis and the useful life of the property. The cost basis includes the purchase price of the property along with any settlement fees, legal costs, and improvements. The useful life is determined by the IRS and varies depending on the property’s classification.
How do you write off depreciation on a rental property?
To write off depreciation on a rental property, you need to follow these steps:
1. Determine the property’s basis: Add up the purchase price, closing costs, legal fees, and any qualified improvements made to the property.
2. Separate the land value: Land is not depreciable, so you need to allocate the purchase price between the land and the building. The land value is generally determined by a property appraiser.
3. Calculate the depreciable basis: Subtract the land value from the total purchase price to arrive at the depreciable basis of the property.
4. Determine the property’s useful life: Check the IRS guidelines to find the appropriate recovery period for your rental property, which can range from 27.5 to 39 years.
5. Use the appropriate depreciation method: Apply the MACRS method to calculate annual depreciation deductions based on your property’s recovery period.
6. Claim the deduction on your tax return: Report the depreciation deduction on Schedule E – Supplemental Income and Loss of your tax return.
FAQs:
1. What is the benefit of writing off depreciation on a rental property?
Writing off depreciation allows you to reduce your taxable rental income, resulting in potential tax savings.
2. Can I claim depreciation on my primary residence?
No, you can only claim depreciation on a rental property or part of your primary residence used for rental purposes.
3. Is land included in the depreciable basis?
No, land is not depreciable. Only the value of the building and qualified improvements can be depreciated.
4. Can I claim depreciation if my property is not rented out?
Yes, as long as your property is available for rent and you actively seek tenants, you can claim depreciation.
5. What happens if I sell a rental property for more than its depreciated value?
Selling a rental property for a gain means you may have to recapture some or all of the depreciation taken over the years. This recaptured amount is subject to a different tax rate.
6. Are there any limits to depreciation deductions?
Depreciation deductions are subject to certain limitations, such as the passive activity loss rules and the at-risk rules. Consult a tax professional for more information.
7. Can I depreciate rental property improvements?
Yes, qualified improvements made to the rental property, such as a new roof or HVAC system, can be depreciated over their useful life.
8. What if I use my rental property for personal use?
If you use your rental property for personal use, such as a vacation home, you can only depreciate the portion of time it’s used as a rental property.
9. Can I claim depreciation on a property held for resale?
No, depreciation is not applicable to properties held for resale. It is only available for income-producing properties.
10. How does depreciation affect capital gains taxes?
Depreciation reduces your cost basis in the property, which can potentially increase the capital gains when you sell the property.
11. Can I claim depreciation on inherited rental property?
Yes, if you inherit a rental property, you can continue to claim depreciation based on the property’s fair market value at the time of inheritance.
12. What happens if I forget to claim depreciation?
If you forget to claim depreciation in a particular year, you can still amend your tax return to include the missed deductions. However, there may be limitations on how far back you can amend. Consult a tax professional for guidance.