Real estate investors enjoy a wide range of benefits in rental property depreciation and tax incentives. Over time, the depreciation on a rental property will result in a loss of value due to age, deterioration, and natural wear and tear from regular use. Owners can use a depreciation schedule to write off the structure and any improvements that have been made to it.
Calculating Rental Property Depreciation
The Internal Revenue Service allows for rental property depreciation if:
- You own the property
- Property is used for your business or for producing income
- Property is subject to a loss of usefulness, and
- Property’s life span expectancy exceeds one year
As soon as the property is available for tenants, rental property depreciation deductions can begin being calculated. The property continues to depreciate until one of the following two conditions is met:
- The entire cost of the property has been deducted, or
- Property is retired from service
Properties may continue to depreciate when they are temporarily not in use, and the depreciation on a rental property can continue after a tenant moves out, and the unit is being prepared for the next occupant.
Rental Property Depreciation Methods
It is always wise to consult with a qualified tax accountant to calculate the depreciation schedule for rental properties. However, there are some basic steps to determining the amount of depreciation that can be deducted from your annual taxes that you should be aware of.
1. Basis of the Property
The amount of money that was paid for a property, either in cash or through a mortgage is considered the basis of the property. Such items as legal and recording fees, surveys, transfer taxes, and title insurance costs are all included in the overall basis of the property. There are some fees and costs that are not included, such as rent relating to occupancy of the property pre-closing and charges connected with getting or refinancing a loan: points, mortgage insurance premiums, credit report costs, fire insurance premiums, and appraisal fees.
2. Separation of Costs between Land and Building
Owners of rental property are not allowed to depreciate the cost of the land. The value of both the building and the land must be determined to calculate the correct rental property depreciation amount. The fair market value of the land and the structure at the time the property was purchased is used to determine the current basis of the property.
3. Determine Adjusted Basis
The basis for your rental property may need adjustments for anything that may happen to the property from the time it was purchased until it is ready for tenants. Funds used for improvements or repairs, utility service expenses, and some legal fees are examples of situations where the basis of your rental property would need adjustment.
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