Rental property depreciation is an essential aspect of real estate investing. It is a tax deduction that allows property owners to recover the costs associated with owning and maintaining their rental properties. Depreciation is the gradual reduction in the value of a property over time due to wear and tear, aging, and obsolescence. However, rental property depreciation does not remain constant and can change over the years. Let’s delve deeper into the various factors that can influence how rental property depreciation changes.
How does rental property depreciation work?
Rental property depreciation works by allowing property owners to deduct a portion of the property’s value as an expense on their tax returns over several years. The Internal Revenue Service (IRS) allows residential rental property owners to depreciate their properties over 27.5 years and commercial property owners over 39 years. This depreciation expense can significantly reduce the property owner’s taxable income.
How does rental property depreciation change?
Rental property depreciation changes over time due to the following factors:
1. Useful life: The useful life of a property affects its depreciation schedule. As the property ages, the depreciation expense may increase.
2. Improvements and renovations: Adding improvements or making substantial renovations to the property can impact the depreciation schedule. The costs of these improvements can be depreciated over a specific period, extending the property’s overall depreciation period.
3. Market conditions: Changes in the real estate market can influence the assessed value of a property and, consequently, its depreciation rate.
4. Fair Market Value (FMV): The fair market value of a property at the time of purchase determines the initial depreciable basis. Changes in FMV can affect the depreciation deduction.
5. Changes in tax laws: Tax laws occasionally change, and these changes can impact the depreciation rules and rates for rental properties.
6. Depreciation method: Property owners can choose from two methods of depreciation: the straight-line method and the accelerated method. Switching between methods can affect the rate at which depreciation changes.
7. Property class: Different property classes have different depreciation rates and schedules. Changing the classification of a property can alter the depreciation rate.
8. Change in ownership: Transferring ownership of a rental property can reset the depreciation schedule based on the new owner’s acquisition cost.
9. Section 179 deduction: Property owners have the option to take a Section 179 deduction, which allows for the immediate expensing of certain property improvements, rather than depreciating these costs over several years.
10. Property condition: The property’s condition and maintenance can impact its value and, subsequently, its depreciation rate.
11. Leasehold improvements: If a property undergoes significant leasehold improvements, additional deductions can be made for the cost of these improvements.
12. Tax basis adjustments: Certain events, such as casualty losses or changes in tax status, can lead to adjustments in the property’s tax basis, which can affect depreciation.
FAQs about rental property depreciation:
1. Can I depreciate the land when calculating rental property depreciation?
No, land is not depreciable. Only the improvements on the land, such as buildings and structures, are depreciable assets.
2. Can I claim depreciation if my rental property is not making a profit?
Yes, you can claim depreciation even if your rental property is not making a profit. Depreciation is a deduction that reduces your taxable income.
3. What happens when I sell a rental property that has been depreciated?
When you sell a rental property that has been depreciated, you may have to recapture the depreciation by reporting it as income and paying taxes on it. However, consult a tax professional for specific details.
4. Can I claim depreciation on rental properties I own outside of the United States?
No, rental properties located outside the United States are not eligible for depreciation deductions.
5. Can rental property depreciation create a tax loss?
Yes, rental property depreciation can create a tax loss that can be used to offset other income and potentially provide a tax refund.
6. Can I claim depreciation on my primary residence?
No, you cannot claim depreciation on your primary residence. Depreciation is only applicable to properties used for business or investment purposes.
7. Do I have to recapture depreciation if I exchange one rental property for another?
If you perform a like-kind exchange (also known as a 1031 exchange) when selling one rental property to acquire another, you can defer the recapture of depreciation. However, once you sell the exchanged property, you will have to recapture the depreciation unless you perform another like-kind exchange.
8. Can I claim depreciation on my vacation rental property?
Yes, you can claim depreciation on your vacation rental property if the property is rented out for more than 14 days a year and your personal use does not exceed the greater of 14 days or 10% of the rental days.
9. Is there a limit to the amount of rental property depreciation I can claim?
No, there is no limit to the amount of rental property depreciation you can claim. It is based on the property’s depreciable basis and the applicable depreciation rate.
10. Can I claim depreciation if my rental property is vacant?
Yes, you can still claim depreciation on your rental property even if it is vacant. However, the property must be available for rent and actively marketed.
11. Can rental property depreciation be taken in the year of purchase?
Yes, rental property depreciation can be taken in the year of purchase, as long as the property was in service (available for rent) during that year.
12. Can I claim depreciation on rental property if it is inherited?
Yes, you can claim depreciation on rental property if it is inherited. The depreciable basis is generally stepped up to the property’s fair market value at the time of inheritance.