RENTAL DEPRECIATION
​
Your rental property depreciation knowledge base
DEPRECIATION IN RENTAL PROPERTIES VS. OTHER ASSETS
Rental properties create an opportunity for investors to make passive income. However, your rental property can deteriorate or wear and tear like other asset types. You can claim rental property depreciation to compensate for the maintenance or repair expenses. The cost of improving or maintaining the property allows investors to enjoy tax incentives.
​
Let's compare depreciation in rental properties and other assets like primary residences, farm animals, woodland and forests, and vehicles.
What is Rental Property Depreciation?
According to the Internal Revenue Service (IRS), property depreciation is an annual tax deduction that allows property owners to recover improvement and maintenance costs. It helps to cover the deterioration the property experiences during its use.
​
One of the most common forms of depreciation is straight-line depreciation. Here, the rental property is reduced evenly over every year during the property's useful life. The rental property depreciation process entails clearing or writing off maintenance expenses on the annual tax returns.
​
The depreciation for residential properties is spread over 27.5 years, while commercial properties have up to 39 years. However, this can vary depending on the type of property. Most taxpayers use the Modified Accelerated Cost Recovery System (MACRS). MACRS has a list of asset classes and their depreciation periods, thus easing the process of determining the amount of property depreciation.
Reporting and Claiming Rental Property Depreciation
You can use different forms to report the property's depreciation, expenses, and rental income. If you have other rental properties, you must fill out each property's details as stipulated by the Internal Revenue Service.
​
This can be overwhelming for most real estate investors, who must meet some qualifications. Besides, some investors don't know what it takes to meet these rules, which ultimately complicates investing in real estate. Working with a certified public accountant can help you navigate through these rules.
​
Most taxpayers use Schedule E of Form 1040, although there are instances where you would use other forms. For example, you can use Form 4562 to claim rental property depreciation on the same year the rental property was put into service. Besides depreciation deduction, property owners can also take a deduction for some property taxes and homeowners insurance.
​
For you to claim rental property depreciation, you must meet specific requirements. They include:
You must own the property
It must be used in an income-generating activity or business
It has a determinable useful life
It should be anticipated to last for more than one year
Depreciation of Primary Residence
You can take some tax deductions on your primary residence to reduce your yearly taxable income. The primary residence depreciation allows you to recover your property's deterioration and normal wear and tear expenses. However, you can only claim the depreciation on your home if you exclusively use it for business purposes.
​
For instance, you can claim primary residence depreciation if you use part of your home as an office, daycare center, or for any other business activity. According to IRS, the space must be separately identifiable and devoted to a business or trade.
​
If you have a stock storage area like a basement or garage, you may be entitled to claim primary residence depreciation. However, you have to prove that you sell retail or wholesale products, these products are stored in your home, your home is your main business location, you use the area regularly, and the space is separate and appropriate for storage.
Depreciation on Vehicles
Your new car starts losing its value as soon you hit the road. Considering the value vehicles add to daily lives, it shouldn't be surprising that you can save big on taxes. Vehicle depreciation can be used to reduce your total taxable income each year. The basic idea behind vehicle depreciation is to spread out the cost of maintaining the car over its useful life.
​
The two common methods used in vehicle depreciation are:
Standard mileage deduction- The Internal Revenue Service annually posts standard mileage rates with all the costs of owning a vehicle. The rates account for repairs, oil, gas, registration, and depreciation. The standard mileage deduction is appropriate for individuals who use their cars to drive to work throughout the year.
Actual expense method- Instead of using a standard rate to calculate depreciation, the actual expense method allows you to claim the exact costs of repairs, oil, depreciation and insurance incurred throughout the year.
Land Depreciation
Land is assumed to have an unlimited useful life, and therefore, it is not depreciated. Among other asset types, land is the only asset that doesn't allow depreciation. When you buy land with a building, the cost should be allocated between the building and the land. In this case, the building will be depreciated but not the land.
Farm Animals
Most animal farmers only factor in the cash costs of operating their animal farms when determining the annual expense for animal farming. Other costs to factor in are animal feed, pasture rent, labor, and depreciation. In this case, livestock for sale should be included as inventory. At the same time, animals held for dairy, breeding or draft purposes can be depreciated or included as inventory. However, that depends on the farm owner's wishes.
​
If you decide to depreciate your livestock, you will receive a depreciation deduction. It is essential to note that any sale up or gain up the depreciation amount will be taxed accordingly. If you prefer to inventory your livestock, you will have to forego depreciation deduction.
Woodland & Forests
Woodland and forest owners can depreciate these properties if they hold them as investments or for business. Although land is not depreciable, you can enjoy tax deductions from the depreciation of temporary roads, fences, buildings, tractors, sawmills, and other improvements made to the woodland.
Final Thoughts
Depreciating assets can be an excellent way for organizations with fixed assets to acquire tax benefits. Under certain tax rules, you can entirely write off specific qualified assets in the same year of purchase. It is essential to consult your tax expert or financial advisor to discover the implications of depreciating your assets.