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Depreciation De-Mystified: An Introduction to Rental Property Depreciation

Dollar Bill Origami of a HouseThere are many financial benefits of investing in rental properties. Some come during tax time when investors get to deduct operating expenses, property taxes, and so on. But on top of all these benefits, investors also get to deduct depreciation. This key tax deduction works differently from the others because of how it’s calculated and applied. Also, failing to take a deduction for depreciation may result in unwanted consequences later on. This is why it’s important for Manvel rental property owners to fully comprehend what depreciation is, how it affects your finances, 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 has recommended that rental property owners should distribute those kinds of deductions over the useful life of the property. In other words, instead of a large lump-sum deduction, owners would be deducting a portion of their purchase and improvement costs (not operating or maintenance costs) each year for several years. This can considerably lower the amount of taxable rental income you write on your tax return, making depreciation worth the time it takes to calculate.

The owner of the property can begin taking depreciation deductions as soon as the rental property is placed in service, or another way to say it: when it’s ready to be rented out. That is welcome news for property owners who have to go through a vacancy, either right after buying the home or during renovations. The length of time you continue to take that depreciation is determined by two factors: How long you own and use the property as a rental, and which depreciation method you use.

There are different depreciation methods you can use 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). Usually, MACRS is used for any residential rental property placed in service after 1986. By using this method, the expense of buying and improving 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 determine how much depreciation you can claim each year, you’ll need to have 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. This number is a bit complicated since there is a 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. Usually, you can use property tax values to calculate what amount of the purchase price should be designated for the house, or your accountant might elect to use a standard percentage.

Once you’ve figured out the amount just for the rental house, you’ll need to take a step further and figure out your adjusted basis. A basis in a rental property can be revised 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 also decrease 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. Beginning 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. However, it’s not very simple or straightforward since rental property tax laws can be complex and change quite a bit every so often. Based on this, it is clear that it’s best to work with a qualified tax accountant. They would ensure that depreciation is being calculated and applied correctly.

When you team up with Real Property Management Prestige, we can connect you with accounting professionals who can help you solve your depreciation questions and more. Our experts can help property owners make sure that you are ready and that there are no unpleasant surprises at tax time. Feel free to contact us online or by phone at 281-532-5455. We’ll be glad to answer any questions you may have about our Manvel property management services.

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