Skip to Content

Get a FREE assessment of your rental property. Start here!

Get a FREE assessment of your rental property. Start here!

Depreciation De-Mystified: An Introduction to Rental Property Depreciation

Dollar Bill Origami of a HouseAmong the financial benefits of investing in rental properties come tax time is when investors get to deduct not only operating expenses, property taxes, and so on, but also depreciation. This key tax deduction works differently from the others because of the way it is calculated and applied. On another note, failing to take a deduction for depreciation can bring a handful of unnecessary repercussions down the line. Thus, it’s relevant for Eastpointe rental property owners to take in what depreciation is and why you should be deducting it on your taxes every year.

Regarding buying and improving rental properties, depreciation is the process used to deduct any associated costs. Rather than take one large deduction in the year the property was purchased or improved, the IRS has indicated that rental property owners should distribute those kinds of deductions over the useful life of the property. Hence, in substance, rental property owners would be deducting a portion of their purchase and improvement costs (not operating or maintenance costs) each year for several years. This can substantially lessen the amount of taxable rental income you record on your tax return, definitely making depreciation worth the time it takes to calculate.

A property owner is allowed to begin taking depreciation deductions as soon as the rental property is placed in service, or that is, prepared to be used as a rental. Well, this is wonderful news for property owners who undergo a vacancy directly after buying or during renovations. For how long you keep on taking that depreciation relies both on how long you own and use the property as a rental, and which depreciation method you use.

There are different depreciation methods that determine the amount you can deduct each year. However, the most common one for residential rental properties is the Modified Accelerated Cost Recovery System (MACRS). Overall, MACRS is utilized for any residential rental property that is placed in service after 1986. In this technique, the outlays of acquiring and further improving a rental property are spread out over 27.5 years. This amount of time is specifically what the IRS considers to be the “useful life” of a rental house.

To work out at what extent your depreciation needs to be each year, you’ll have to figure out your basis in the property or the amount you paid for it. You could be able to include some of your settlement fees, legal fees, title insurance, and other costs paid at the settlement. The arduous part of this number is that you’ll have to carefully separate the cost of the land from the building since only the rental house itself – and not the land it is built on – can be depreciated. Usually, you may use property tax values to help you establish what extent of the purchase price has to be commissioned to the house, or your accountant might elect to use a standard percentage.

And when you have a total amount for the rental house, you’ll want to take one step further and figure out your adjusted basis. A basis in a rental property might be revised to account for things like major improvements or additions, money spent restoring extensive damage, or the cost of connecting the property to local utility service providers. Basis can possibly even decrease in the event of insurance payments you received to cover theft or damage and any casualty losses you took a deduction for already that were not covered by your insurance. Utilizing your adjusted basis, you should now be able to calculate the amount of depreciation you can deduct on your income tax return.

Depreciation of a rental property is a valuable tool for investors looking to reduce their annual tax obligation. On the other hand, rental property tax laws can be complex and change quite a bit as time goes on. Because of this, it’s best to work with a qualified tax accountant to ensure that depreciation is, in fact, being calculated and applied correctly.

When you engage Real Property Management Metro Detroit, we can actually help connect you with accounting professionals who can aid you with your depreciation questions and more. Engaging our experts can help property owners make sure that there are no unpleasant surprises throughout tax time. For additional info concerning our Eastpointe property management services, contact us online or give us a call immediately at 248-808-6550.

We are pledged to the letter and spirit of U.S. policy for the achievement of equal housing opportunity throughout the Nation. See Equal Housing Opportunity Statement for more information.