A profitable rental property can allow investors to earn passive income and diversify their investment portfolios. Of course, like any building, a rental property will eventually require maintenance. Rental property depreciation can help to compensate landlords for the expense of upkeeping their property.
In this article, we’re explaining everything Brevard County landlords need to know about rental property depreciation.
What Is Real Estate Depreciation?
Rental property depreciation is a tax deduction landlords can take for their property. To do this, you must calculate your investment property’s “determinable useful life” and then use this to calculate any value lost due to depreciation. This figure can then be used to inform the IRS and claimed as a deduction on your tax return.
To claim real estate depreciation, your property must meet the following criteria:
- It must be owned by you.
- It must produce income for you (for example, through rent).
- It must have a “determinable useful life.”
- The “determinable useful life” must be greater than one year.
In addition, you cannot depreciate a property that is purchased and sold in the same tax year. For example, if you flip a house and rent it for a couple of months before deciding to sell it, it wouldn’t be eligible to claim depreciation.
It’s important to note that determining real estate depreciation and correctly filing taxes can be complicated, so it’s crucial to always seek advice from a tax accountant about your specific situation.
Determining The Useful Life Of Your Property
To avoid any confusion, the IRS has standardized the “useful life of property.” There are two potential depreciation systems a landlord can use:
General Depreciation System (GDS)
The general depreciation system is the most commonly used system for depreciation. GDS utilizes a “declining balance” method to depreciate property. In this method, the depreciation rate is applied against the non-depreciated balance. For instance, if your property costs $200,000 and is depreciated at 2.5% each year, the deduction would equal $5000 in the first year and $4875 in the second year, and so on. The useful life of residential rental property under GDS is 27.5 years.
Alternative Depreciation System (ADS)
Using the ADS method, depreciation is set as an equal amount each year, excluding the first and last year, which is prorated to the number of applicable months. While the ADS method increases the useful life of residential rental property to 30 years, it also has a lower annual depreciation cost.
Although you can choose what system you want to use on a property-by-property basis, once you’ve decided, you must use that particular system as long as you claim depreciation.
How To Determine Your Rental Property Cost Basis
Your cost basis is the beginning value you will subtract any future depreciation from. First, you need to confirm your property value. This is typically the amount you paid for your investment property. In addition to the sales price, you can include other qualified costs such as recording fees, property taxes, title insurance, legal fees, surveys, and more. For example, if you purchase an investment property for $250,000 and pay $15,000 in eligible closing costs, your cost basis will equal $265,000.
As land is not a depreciated asset for tax purposes, you do not include the value of the land when calculating the cost basis of your property. Your property tax bill can help you determine the value of your land versus the value of the building on it.
It should be noted that in the first year of depreciation, you can only depreciate your property for the amount of time it has been “in service.” The IRS provides tables to help landlords determine what percentage of depreciation they can take in the first year. Before calculating depreciation on your rental property, it’s essential to seek advice from a knowledgeable tax accountant.
Property Management in Brevard County
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