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Depreciation De-Mystified: An Introduction to Rental Property Depreciation

Dollar Bill Origami of a HouseThere are certain financial benefits of investing in rental properties. A few of them take effect when tax time comes and investors get to deduct operating expenses, property taxes, and so on. And on top of that, there is another thing they can deduct— depreciation. This key tax deduction works differently from the others because it’s 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 Suwanee 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 stated that rental property owners should divide the amount of those kinds of deductions over the useful life of the property. To state it differently, owners shouldn’t have a one-time deduction of the purchase cost, but instead, they should 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 can begin taking depreciation deductions as soon as the rental property is placed in service, or to simply put: when it’s ready to be rented. That’s favorable news especially if you’re a property owner who has to deal with a vacancy right off the 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 use different approaches to determining the annual expense. You may use any of them 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). Most often, MACRS is used for any residential rental property placed in service after 1986. Through this method, the cost to buy and upgrade 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 assess the amount of your depreciation you can deduct each year, you should 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.

As soon as you get the amount that’s just for your rental house, you’ll need one more step. That is to figure out your adjusted basis. A basis in a rental property can 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. 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 start 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, it’s not very simple or straightforward since rental property tax laws can be complex and change quite a bit every so often. Based on this, it is clear that it’s best to work with a qualified tax accountant. They would ensure that depreciation is being calculated and applied correctly.

When you employ Real Property Management Executives Greater Atlanta, we can have accounting professionals guide you through your depreciation questions and more. Our experts can help property owners make sure that you are ready and that there are no unpleasant surprises at tax time. Don’t hesitate to contact us online or give us a ring at 678-504-8580 to know more about what our Suwanee property management services can do for you.

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