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Understanding Real Estate Depreciation, Rental Income Taxes and All That Complicated Stuff

  • 30th November 2017

Written by Samantha Moate

When it comes to owning rental property, we’ve all heard that there are potential tax advantages. But did you know that there are plenty of ways to benefit from a tax perspective? By making the most of real estate depreciation and expense write-offs, you can enjoy the true monetary rewards of your property investment. Get your notebook ready and get saving!

Real Estate Depreciation

Depreciation might initially sound like bad news for any property investor, but actually this is one of the biggest benefits to investing. Why? Because the longer that a building stands, the more it loses value due to age, wear and tear and general deterioration – all of which reduces the amount of net income you need to report, which in turn reduces your taxes.

But how do you go about calculating the tax reduction you’re entitled to?

The primary thing to know is that land itself is not depreciable. The building and equipment used in the operation of the property, however, are. Depreciation commences when a taxpayer places property in service, and ends when the property is disposed of or otherwise removed from service. In order to calculate the tax reduction you’d be entitled to for the building, the first step is to deduct the value of the land from the cost of the building, like so:

Cost of the Building – Value of the Land = Building Value

Depreciation is certainly a long-term game, as the IRS allows an owner to depreciate the value of a home over a 27.5 year period for a residential property, and 39 years for a commercial property.

In order to therefore work out your depreciation expense, simply divide the building value by 27.5 or 39 depending on your property, like so:

Building value / 27.5 = Yearly allowable depreciation deduction.

Multiply this figure by your marginal tax rate and you’ll get the exact amount that you have the potential to save from real estate depreciation.

Ultimately, if you’re on the rental market and plan on renting your property for many years to come, it’s important to depreciate your building properly. If you didn’t know you could deduct it or forget to, the IRS will assume it has been taken – which means that when it comes to selling later down the line, you may end up paying taxes on depreciation recapture that you never actually benefited from.

But don’t panic! If you haven’t taken it, it’s not too late. You can always file an amended return and claim that lost depreciation.

Write Offs

Aside from depreciation, another way in which to save money on a rental property is through written off expenses. Did you know, for example, that there are a whole extensive list of expenses incurred when owning a rental property that can be written off at tax time? You’d be surprised how much you could write off – everything from expenses used for maintaining and managing the property (including any salaries for those hired to work for or on the property such as plumbers and electricians), right through to property taxes and utilities as well.

Any property advertising, as well as expenses from background and credit checks on new tenants and even cleaning costs between tenants, can be written off.

And what if you’ve got property abroad? Some (note – some, not all!) of your travel expenses can be written off too. That doesn’t mean you get to buy a house in the Bahamas, lay on the beach for ten days and write the entire trip off. But if the primary purpose of your trip is for rental activity – such as looking at potential new properties, dealing with repairs, showing people round – all of those costs can be written off. So do your research, see what you can remove and get saving!

Got any further questions about rental properties and the rights or tax deductions you’re entitled to? Get in touch with our Move Now team today!