RENTAL DEPRECIATION
​
Your rental property depreciation knowledge base
CALCULATING RENTAL PROPERTY DEPRECIATION
Real estate is one of the most tax-advantaged investment vehicles in the market, and this is for a good reason. Property owners who rent their properties are allowed to deduct some portions of taxes on their income. The primary means of decreasing taxes is attained through depreciating the property.
​
Generally, depreciation is the recovery of write-off costs, costs to repair and maintain properties, rent default insurance, and landlord tax deductions. If you're planning to invest in real estate, read on to understand what rental property depreciation is and how it works.
How Does Rental Property Depreciation Work?
According to the Internal Revenue Service (IRS) Publication 527, rental property is depreciated over 27 and a half years. This is done by reporting to the IRS that the rental property under concern has a justifiable useful life. After determining the property's useful time frame, you can apply a formula to compute the actual value lost through depreciation annually before claiming the reduction or elimination of your taxes.
​
Rental property depreciation is declared using Schedule E (tax form 1040). Sometimes you may be required to use other tax forms. If you're unsure which form to use, you should consult a financial advisor or tax preparer.
​
If your property is used for rental purposes, you must report your rental earnings while filing taxes. There are a few exceptions to this rule, though. For example, if your property is used primarily as a residence or has been rented for less than 15 years, you may not be allowed to deduct rental costs.
Who Is Eligible to Claim Rental Property Depreciation?
As an investor, your rental property must fulfill certain conditions to qualify for depreciation for tax deductions. They include:
You must be listed as the property owner and not a renter. There are a few exceptions to this condition.
The rental property must be used as an income-generating investment, such as rental apartments.
The property must have been held for at least twelve months to qualify for the depreciation expense claim.
You should be able to determine the useful life of your rental property.
Calculating Rental Property Depreciation
The depreciation of a property is spread evenly throughout its service life. Computing property depreciation involves three steps: establishing your property's cost basis, determining its useful life under a selected depreciation method, and calculating the property's depreciation schedule.
​
1. Determining Property Cost Basis
Before calculating depreciation, you must first determine your rental property's cost basis. In its essence, the cost basis represents the property's value without including the value of the land where the property sits. Then add any qualified closing costs, such as property taxes, legal fees, property survey, abstract fees, transfer taxes, and recording fees.
​
A simple example: calculate the cost basis of a property based on the following information:
​
Buying price = $ 298,000
Less land value = $ 17,000
Add closing costs qualified for depreciation = $1,500
Cost basis = $282,500
​
2. Divide the Cost Value by the Rental Property's Useful Life
​
The annual value of depreciation on the rental property is calculated by dividing the cost basis by the rental property's service life. In this case, we take our existing cost basis of $282,500 and divide it by 27.5 years, meaning your annual depreciation expense will be $10,282.73 per year.
​
3. Depreciation Schedule
​
Remember that in the first year of purchasing your property, you can only claim depreciation expense for the period it's been in use. The IRS provides a table outlining the costs basis depreciation percentage based on the month the property is placed into service.
​
Suppose your rental property has a 4-year ownership period. In that case, using our existing annual depreciation cost, you will be able to claim a depreciation expense of $51,413.65 to cut the value of taxable net income.
​
Technically, if your rental property made a total pre-tax of $58,000 within the four years, you would only pay $6,586.35 in taxes.
​
i.e., $58,000 pre-tax earnings - $51,413.65 depreciation cost = $6,586.35 taxable income
Calculating Depreciation by Month
You can claim a depreciation cost of 3.636 percent of your investment property annually. But unfortunately real estate business is not a straight line where the rental property is bought and sold in the first month of the year and at the end of the year. And this is where the IRS table comes into play.
​
For example, if your rental property with a $150,000 in value was first placed in service in May, the depreciation for that month would be 2.27, so the value would be:
​
$150,000 cost basis X 2.27% = $3,405
Annual depreciation expense: $150,000 X 3.636% = $5,454