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Depreciation De-Mystified: An Introduction to Rental Property Depreciation

Dollar Bill Origami of a HouseThere are some financial benefits of investing in rental properties. A number of them are actualized during tax time when investors get to deduct operating expenses, property taxes, and so on. But there’s one more thing investors can deduct, and that is depreciation. This key tax deduction works differently from the others because, by its nature, it must be calculated and applied differently. Also, failing to take a deduction for depreciation can bring about issues in the future. Because of this, it’s important for La Cresenta rental property owners to grasp what depreciation is, how it works, and why you should be deducting it on your taxes every year.

In terms of 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 prescribed that rental property owners should split those kinds of deductions across the useful life of the property. To put it another way, owners would not go with one large deduction on the date of purchase but will be deducting a portion of their purchase and improvement costs (not operating or maintenance costs) each year for several years. This could largely reduce the value of taxable rental income that you report on your tax return, making depreciation worth the time it takes to calculate.

Property owners may begin taking depreciation deductions as soon as the rental property is placed in service, or in essence: ready to be used as a rental. That is some positive news for property owners who have to face a vacancy just after purchase or during renovations. The duration you continue to deduct depreciation depends on how long you own and use the property as a rental, and which depreciation method you use.

There are different depreciation methods that give different amounts. Anyone of them can be used to determine the amount you can deduct each year. But the most common one for residential rental properties is the Modified Accelerated Cost Recovery System (MACRS). Generally, MACRS is used for any residential rental property placed in service after 1986. Using this method, the cost to buy and improve a rental property is spread out over 27.5 years, which is what the IRS considers to be the “useful life” of a rental house.

To find out how much your depreciation should be each year, there are a few things you’ll need. You’ll need to know your basis in the property or the amount you paid for it. You may also be able to include some of your settlement fees, legal fees, title insurance, and other costs paid at the settlement. This number is quite complicated because you’ll need to 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. For the most part, you can use property tax values to help figure out how much of the purchase price should be designated for the house, or your accountant might elect to use a standard percentage.

When you’ve arrived at the amount designated for the rental house alone, you’ll have to do one more task— to figure out your adjusted basis. A basis in a rental property can be raised 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. The basis can decrease, too, 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. Using your adjusted basis, you can begin 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. However, rental property tax laws can be complex and change quite a bit over the course of a few years. Because of this, it’s best to work with a qualified tax accountant to ensure that depreciation is being calculated and applied correctly.

When you avail of the services of Real Property Management East San Gabriel Valley, we can get you in touch with accounting professionals who can address your depreciation questions and more. Teaming up with our experts can help property owners make sure that there are no unpleasant surprises when tax time comes. Please contact us online or call us at 626-600-2884 to learn more about how our La Crescenta property management services can serve you.

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