When you think of the word “depreciation”, you might think of it in a negative context. After all, depreciation typically refers to an asset’s loss of value over time, usually due to wear and tear. It’s the reason your car won’t be worth as much in five years as it was when you bought it. Real estate almost always appreciates (increases in value). Even so, landlords can use depreciation on a rental property to their advantage. When tax time rolls around, landlords can potentially save a lot of money by claiming rental property depreciation as a tax deduction. Let’s take a closer look at how that works.
What is Depreciation on Rental Property?
First, let’s adjust our concept of what “depreciation” is. For tax purposes, depreciation isn’t really about a decline in value of your property. It’s about how you, as a property owner, can spread the cost of your property over a span of years. Even if your property maintains or even increases its value, you can still use depreciation as a tax write-off.
Simply put, depreciation is the process by which you can deduct the cost of buying or improving a rental property over the course of the property’s useful life. Rather than taking one large tax deduction all at once, you essentially get to claim many smaller deductions over several years.
The two most common things property owners can depreciate are:
- The cost of buying a rental property
- The cost of improving a rental property
The amount of time over which you can depreciate your rental property—and the percentage you deduct each year—may vary. Traditionally, residential rental property is depreciated at a rate of 3.636% annually, over the course of 27.5 years.
What can (and can’t) be depreciated
Broadly speaking, buildings can be depreciated if they meet certain criteria, but land can never be depreciated. Most rental properties meet the criteria for depreciation. According to the IRS, you can depreciate property if it meets these requirements:
- You are the owner of the property.
- You use the property for your business or as an income property (i.e. rental property).
- The property has a “determinable useful life,” meaning that it will wear out or become “used up” over time. This stipulation is the reason why a house or building can be depreciated, while the land itself cannot.
- The property’s determinable useful life is greater than one year.
The cost of buying a rental property is not the only thing you can depreciate on your taxes. Improvements to a rental or income property can also be depreciated.
In order to qualify, the improvements must either enhance the usefulness or value of the property, adapt it to a new use, or restore it to like-new condition. Examples of improvements that may be depreciated include building a new garage or addition to the property, replacing the roof, installing a new heating or air conditioning system, or adding new accessibility upgrades.
Routine repairs and maintenance are not considered improvements, and thus are not depreciable. These expenses are deducted separately as maintenance costs, and must be deducted the year you make them.
Tax help for landlords
If you find all this talk about depreciation and tax deductions confusing, you’re certainly not alone. Filing your taxes as the owner of rental properties can be complicated. That’s one reason why many landlords choose to work with a professional property management company. Among the many jobs that property managers do, they handle all the financial and accounting aspects of rental property ownership, which makes everything much easier when tax season rolls around.
Contact us today to learn more about depreciation and rental properties, and talk to our team about how the services of a professional property management company can give you peace of mind.