Rental Property Depreciation

Most of the times, investing in real estate business can be very profitable and cash generating. The real estate investments become a stable source of constant income with a very little to worry about. The profit margin gradually increases as the investor reaches equity. In ideal situations the value of the property rises with time. Along with all other benefits there are tax benefits as well. The tax liability can be lowered if the tax payments and rental expensed are deducted from the rental incomes. Depreciation is the process of lowering the cost of a rental property while simultaneously upgrading the property. Depreciation distributes the deduction over the life of the property instead of a single large yearly payment.

Properties that are depreciable

A property can be depreciated if it meets certain requirements. If the property is owned by an investor or it is being used in a business or for generating income by the investor, the property can be depreciated. If the property has a determinable life and one can judge its lifespan, then it can be depreciated. The same case applies even if the property can last more than a year. But if the property meets all the requirements it cannot be depreciated. One cannot depreciate the costs of clearing, planting and landscaping etc.

Beginning and ending of depreciation

Depreciation may begin as soon as the property is available for providing service or can be now used as a rental. The depreciation process can continue until the entire cost is deducted or the property is retired from service before its cost is deducted. Even if the purpose of the property is changed it is no more depreciable.

Method of depreciation

The property decides the amount that is deducted each year. Certain accounting techniqies are applied to calculate the amount. A qualified tax accounted should be consulted when the depreciation is being calculated.

Determining the basis of the property

The cost of the property is its basis to calculate the depreciation. The amount that was paid as cash or mortgage can also form the basis of the property. All types of costs are included in the basis such as the settlements fees, closing costs and the transfer fees etc. Any insurance availed at the time of purchasing the property is also included.  

Separating the cost of land and property

As already mentioned that the cost of the land cannot be depreciated. The value of the land and the property should be accurately calculated so that the correct amount to be depreciated can also be calculated. To determine the value of the property the fair market value should be checked and the cost of land should be deducted from the total cost.

Depreciation reducing tax liability

When we rent a real estate property the rental income is reported. When the annual tax return is filed, the net gain or loss is listed in the form. The depreciation is also a part of the expenses that are listed on the schedule E, so the depreciation amount will effectively reduce the tax liability of the year.

Conclusion

To sum up, anyone who enters the real estate business can get advantage of the depreciation. It allows the buyer to spread the cost of buying the property is spread across a number of years. If the property is depreciated and sold after that the seller will have to pay the tax on the gain through depreciation recapture tax. The rental property laws are complicated and change over time so the investor should try to work with a qualified accountant so that he may not face any unwanted situation.