Tax 101: Guide to Rental Property Depreciation
How to Maximize Tax Benefits from Rental Property Improvements
Many people get into real estate because it has the potential to provide a steady income flow, and many landlords and investors see some tax benefits too. One tax benefit investors and landlords can use is rental property depreciation—a key lever in helping maximize tax savings.
Essentially, rental property depreciation is a way for real estate investors and landlords to deduct the costs of buying and improving a rental property.
Here's our guide for what owners and investors need to know for tax season.
How It Works
Typically, most of the tax deductions a property owner is eligible for—things like mortgage insurance, property taxes, and HOA fees—can get deducted from any rental income earned in a particular year. The costs of these one-year expenses get written off on your tax forms for that particular tax year.
However, there are instances where costs and expenses can significantly improve your property for years to come. For example, if you spend $10,000 on a new heating system in a rental home, the benefit for that heating system will last years into the future. This is where rental property depreciation really has its benefits.
With a rental property depreciation deduction, landlords and investors can take the depreciation reduction over the "useful life" of the property.
Determining Depreciable Properties
When it comes to real estate investing, not all properties are equal—and that's especially true when it comes to claiming rental property depreciation. For many rental property owners, the actual purchase of the property is the biggest asset of them all.
In order to get the tax benefits of property depreciation, however, the Internal Revenue Service (IRS) has guidelines that the property must meet:
There are a few other considerations to keep in mind too. You can't claim any rental property deductions if you have sold or no longer use the property for business purposes in less than one year.
Also, land is not considered depreciable. For calculating the total value of the rental property for depreciation, the value of the land (based on fair market value and real estate tax assessments) gets deducted from the total property valuation as you make your calculations.
Finally, once your property is ready for occupancy, you can start to take depreciation deductions. This lasts until you've deducted all those costs over time or the property is no longer in use in a business or income producing capacity.
For more tax advice on deductions and record keeping, the IRS has a guide for rental owners and investors.
Doing the Basic Math
To get the full benefit of the investment, you'll need to capitalize and depreciate the costs you've spent over the useful life of the improvements you made.
So if, for example, the new heating system costs $10,000 and the useful life of the heating system as noted by the IRS is 27.5 years, you can write off $364 each year—the cost divided by the number of years of useful life.
The IRS has tables that delineate the useful life of common investment property repairs and expenses. It's also a good idea to seek out the tax advice of an accountant who specializes in investment properties to ensure you're maximizing your potential benefits.
Whether you've started investing in real estate or are thinking about purchasing your first rental property, understanding how rental property depreciation can benefit you is key to getting tax advantages over the long term.