How Rental Property Depreciation Works: Taxes, Benefits, Benchmarks & More

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Taxes can greatly affect your finances. According to recent government stats, the average American family paid $15,748 in taxes in 2018. If you own a rental property, you can reduce your tax bill through rental property depreciation. It’s a deduction that spreads out the costs of owning and maintaining a rental property over its lifetime. Instead of a large deduction in the year of purchase, you can spread it out over many years for maximum benefit.

The IRS acknowledges that rental properties lose value over time due to wear and tear. Residential properties have a useful life of 27.5 years, while commercial properties have a life of 39 years. You can deduct the annual depreciation expense from your income over these years. After that, the property is considered worn out for tax purposes.

However, not all rental properties qualify for depreciation. The IRS has strict guidelines, which you can find on their website. The key factors include property ownership, business use, useful life, and property depreciation (not the land).

Depreciation begins when the property is ready for renting and generating income. It usually ends when the property reaches the end of its life or is no longer used for business purposes. For instance, if you purchased a property in 1993 and it has been a rental since then, its useful life would have ended in the 2021 tax year. If the property is no longer used for business, such as being turned into a vacation home, you cannot claim depreciation anymore.

Understanding rental property depreciation can help you make informed decisions about taxes and financial planning.

Now that we’ve explained real estate depreciation and its benefits for property investors, let’s discuss how to calculate depreciation for your rental property. If you purchased the property after 1996, follow the modified accelerated cost recovery system (MACRS) for depreciation calculation. This system offers various depreciation methods to choose from.

To calculate rental property depreciation using the general depreciation system (GDS), follow these steps:

  1. Determine the initial cost basis of the property: This includes the purchase price and certain closing costs like legal fees and transfer tax. Exclude appraisal fees, mortgage insurance premiums, and credit report costs.
  2. Segregate land and building costs: Separate the land cost from the building or structure cost based on real estate tax values.
  3. Establish the basis for the rental property: Allocate a percentage of the purchase price to the rental property structure and the remaining percentage to the land.
  4. Adjust the basis if required: Significant improvements can increase the cost basis, while damages or losses can decrease it.
  5. Determine your depreciation percentage: Use the GDS depreciation method, which allows for a 3.636% deduction from the property’s value each year over a 27.5-year recovery period.
  6. Calculate the total depreciation amount: Multiply the property basis by the depreciation percentage to get the annual depreciation amount.

Consult a tax professional for specific property-related queries. Depreciation can be reported as an expense on your income tax return, reducing your overall tax liability. It offers double-dipping benefits, allowing you to deduct both depreciation and maintenance costs.

Real estate depreciation can result in substantial long-term savings. In the example mentioned earlier, if you depreciated $6,908.4 and fall into the 24% tax bracket, you could save $1,658 on your next tax bill.

Invest in Rental Properties with Foothold: Tax Advantages & More

Investing in rental properties has become easier, and now many can benefit from substantial tax advantages through depreciation. In the past, only those with the financial means to buy and manage properties could take advantage of depreciation deductions. However, recent technological advancements have changed this. 

With Foothold, you can invest in real estate without needing significant capital. Foothold handles property depreciation and passes the savings to you, eliminating the need to buy or manage properties individually. Start building your real estate portfolio, reduce your tax liabilities, and explore our available properties at your convenience. You might find unexpected opportunities. 

Please note that the information provided here is for general purposes only and does not offer specific advice or recommendations for any individual or investment product. These views are subject to change without prior notice. Please review Foothold’s disclaimers for more information.

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