Maximizing Your Tax Savings: A Guide to Rental Property Depreciation

As a rental property owner, it’s important to be aware of all the tax deductions available to you in order to maximize your savings. One such deduction is depreciation, which allows you to deduct a portion of the cost of your property over a period of several years.

In this guide, we’ll explain what depreciation is, how it works, and how you can use it to save money on your taxes. Whether you’re a seasoned landlord or just starting out, understanding depreciation can help you keep more of your hard-earned income.

What is Rental Property Depreciation?

Rental property depreciation is a tax deduction that allows landlords to deduct a portion of the cost of a rental property over a period of several years.

The purpose of this deduction is to account for the wear and tear that occurs on a property over time. As well as any obsolescence due to changes in technology or market conditions.

How is Rental Property Depreciation Calculated?

The depreciation is calculated by dividing the cost of the property (less the land value) by the number of years in the recovery period.

This amount can then be deducted from the landlord’s taxable income each year.

 

For example, let’s say a landlord buys a rental property for $500,000, with $50,000 of that being the land value. The depreciable cost would be $450,000 (cost of the property minus land value). Over a 27.5-year period, the landlord would be able to deduct $16,364 per year ($450,000 / 27.5) from their taxable income.

It’s important to note that landlords can only claim depreciation on rental properties. That they actively use to generate income and not on their personal residence. Also, when the property is sold, depreciation recapture tax may apply on the amount of depreciation taken previously.

How can you use Rental Property Depreciation to Save Money on Your Taxes?

Rental property depreciation can be a powerful tool for saving money on taxes. As it allows landlords to deduct a portion of the cost of their property over several years. Here are a few ways landlords can use depreciation to save money on taxes:

1. Claim The Full Amount Of Depreciation

Landlords can claim the full amount of depreciation they are entitled to each year. Which can reduce their taxable income and lower their overall tax bill.

2. Plan Your Depreciation Strategically

Landlords can plan their depreciation in a way that maximizes their tax savings. For example, if a landlord expects their income to be higher in a particular year. They may choose to claim more depreciation that year to lower their taxable income.

3. Combine Depreciation With Other Deductions

Landlords can also use depreciation in conjunction with other deductions. Such as mortgage interest or property repairs, to further lower their taxable income.

4. Be Aware Of Depreciation Recapture

Landlords should be aware that when they sell a property, they may be subject to depreciation recapture tax on the amount of depreciation they have claimed in previous years.

By understanding and utilizing depreciation, landlords can effectively lower their tax bill and keep more of their hard-earned income.

It’s important to consult with a tax professional to ensure compliance with tax laws and regulations and to fully understand the benefits and drawbacks of depreciation. As well as any other deductions that may be available.

Rental Property Depreciation in the Light of IRS

The IRS allows landlords to depreciate their rental property over a period of 27.5 years for residential properties and 39 years for commercial properties.

This means that landlords can deduct a portion of the cost of the property each year over the useful life of the property.

In order to take advantage of this tax benefit, landlords must first determine the property’s basis. Which is the cost of the property plus any capital improvements made to the property.

Landlords must also use the property for income-producing purposes, and the property must have a useful life of more than one year.

 

Additionally, there are limits to the depreciation deductions that can be taken in a given tax year. The IRS has placed a cap on the amount of depreciation that can be taken each year using the Modified Accelerated Cost Recovery System (MACRS).

The rules for this change every year and are dependent on the year of acquisition of the rental property and whether it’s residential or commercial property.

It’s important to note that when a landlord sells a rental property. Any depreciation taken on the property will have to be “recaptured” at the time of the sale. This means that the landlord will have to pay taxes on the depreciation taken at a rate of 25% if the property is a residential one and a rate of 35% if it’s a commercial one.

When Does Rental Property Depreciation Start?

Rental property depreciation starts on the date the property is placed in service. Which is when the property is available for rent or is actually being rented.

This date is typically when the property is first available for rent to tenants or when the property is first occupied by tenants.

It’s important to note that a property is considered placed in service when it is substantially completed and ready for its intended use.

 

So, when a landlord is in the process of building or renovating a rental property. They can’t start taking depreciation until the property is ready for tenants.

Also, the landlord must use the property for income-producing purposes, meaning it’s available for rent. If the property is not occupied for a period of time, it does not qualify for depreciation.

How To Claim Rental Property Depreciation?

To claim rental property depreciation, landlords must file Form 4562, Depreciation and Amortization, with their federal income tax return each year. The form is used to calculate the amount of depreciation that can be taken for the tax year.

Here are the General Steps to Claim Rental Property Depreciation:

• Determine the Cost Basis of the Property: This is the original cost of the property plus any capital improvements made to the property.
• Determine the Useful Life of the Property: The IRS allows landlords to depreciate residential properties over a period of 27.5 years and commercial properties over 39 years.
• Calculate the Annual Depreciation Deduction: The annual depreciation deduction is calculated by dividing the cost basis of the property by the number of years in the useful life of the property.
• Report the Depreciation on your Tax Return: Landlords must report the annual depreciation on Form 4562 and attach it to their tax return.
• Report the Sale of the Property: If the landlord sells the property, they must report the sale on their tax return and “recapture” any depreciation taken on the property, which is generally taxed as ordinary income.

 

It’s important to note that the rules and regulations regarding rental property depreciation are subject to change. It’s important to consult with a tax professional to ensure that you are taking depreciation correctly.

The Bottom Line

Depreciation is an important tax benefit for landlords as it allows them to deduct a portion of the cost of their rental property each year over the useful life of the property.

By understanding the rules and regulations set by the IRS and correctly calculating and reporting depreciation on their tax returns, landlords can maximize their tax savings.

It’s important to consult with a tax professional to ensure that you are taking depreciation correctly and to stay up-to-date with any changes in the laws.

Remember that when you sell the property, you’ll have to recapture depreciation taken, and it will be taxed. Overall, depreciation can be a great way for landlords to reduce their tax liability and to make their rental property investment more profitable.