Rental properties wear out. This may be through wear-and-tear, structural age or an obsolete design for today’s needs. When filing your taxes, rental properties are treated like any other source of income, and expenses are deductible.
This expense may be in the form of property depreciation. Depreciation for tax purposes is allowed on both residential and non-residential real estate, including furniture and fixtures, but not including land. There are two methods of calculating depreciation: straight-line depreciation and declining balance depreciation. Each method is used for different elements of your real estate portfolio.
Depreciation for both residential and non-residential real estate, not including furniture, appliances or fixtures, is calculated using the straight line method. Such property may only be depreciated if it is expected to last more than one year. To calculate depreciation using the straight line method, you must first obtain the cost basis for your property. The cost basis is the lower of either the acquisition cost of the property, i.e., the amount you paid minus associated expenses, or the market value at the time the property was converted to rental use.
Next, divide the cost basis of your property by its useful life in years. According to the IRS, the useful life for residential property is 27.5 years, and 39 years for commercial property. This gives you the depreciation per year, in dollar terms. If you have had the rental property for less than a year, the depreciation per year is divided into a monthly rate, with a half a month representing the first month.
Declining Balance Depreciation
For other elements of your property rental, such as fixtures, furniture, fences and trees, the declining balance depreciation method is used. Most appliances, including refrigerators, desks, carpets and stoves, are regarded by the IRS to have a useful life of five years. Others, such as shrubbery and fences, have a useful life of 15 years. The IRS publishes tables to help you calculate the depreciation on such items for each year.
James Green has composed economic research reports on a freelance basis since 2008. Specializing in business and finance, Green possesses a Master of Science in real estate from the University of Aberdeen and a Master of Science in economics from the University of Lund.
The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on your taxes, your investments, the law or any other business and professional matters that affect you and/or your business.