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 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 of the unique way it’s calculated and applied. Also, failing to take a deduction for depreciation can lead to problems down the road. This is the reason why it’s important for Marietta rental property owners to know what depreciation is 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. So basically, instead of a large one-time deduction, owners would be deducting a portion of their purchase and improvement costs (not operating or maintenance costs) each year for several years. This could dramatically reduce the amount you report as your taxable rental income. The huge effect this has on your tax return makes depreciation well worth the time it takes to calculate.

A property owner can begin taking depreciation deductions as soon as the rental property is placed in service, or stated another way: when it’s ready for rental. That is certainly good news for property owners who have a vacancy right after buying the home or during renovations. The amount of years that you’d take the depreciation is set by two things. The first one is how long you own and use the property as a rental, and the second one is 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. What makes this number difficult to get is that 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. In most cases, you can use property tax values to find out what portion of the purchase price should be allocated for the house, or your accountant might elect to use a standard percentage.

As soon as you have the amount for the rental house alone, you’ll need to move a step forward and figure out your adjusted basis. You can increase the basis in a rental property 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 may decrease as well, 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. Starting with your adjusted basis, you can now 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. But things are more complicated since rental property tax laws can be complex and change quite a bit now and then. This is why it’s best to work with a qualified tax accountant to ensure that depreciation is being calculated and applied correctly.

When you hire Real Property Management East Cobb, we can link you with accounting professionals who can help you answer all your depreciation questions and more. Coming together with our experts can help property owners make sure that there are no unpleasant surprises at tax time. Don’t hesitate to contact us online or give us a ring at 770-622-5657 to know more about what our Marietta property management services can do for you.

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.