There are some financial benefits when investing in rental properties. A number of them are actualized during tax time when investors get to deduct operating expenses, property taxes, and so on. But there’s one more thing investors can deduct, and that is depreciation. This key tax deduction works differently from the others because of how it’s calculated and applied. Also, failing to take a deduction for depreciation can make things problematic for you down the road. Because of the potential repercussions, it’s important for Baton Rouge rental property owners to fully understand depreciation, how to use it properly for your benefit, and why you should be deducting it on your taxes every year.
In terms of buying and improving rental properties, depreciation is the process used to deduct any associated costs. Rather than take one large deduction in the year the property was purchased or improved, the IRS stated that rental property owners should divide the amount of those kinds of deductions over the useful life of the property. To state it differently, owners shouldn’t have a one-time deduction of the purchase cost, but instead, they should be deducting a portion of their purchase and improvement costs (not operating or maintenance costs) each year for several years. This could largely reduce the value of taxable rental income that you report on your tax return, making depreciation worth the time it takes to calculate.
The owner of the property can begin taking depreciation deductions as soon as the rental property is placed in service, or another way to say it: when it’s ready to be rented out. That is some positive news for property owners who have to face a vacancy just after purchase or during renovations. The length of time you continue to take that depreciation is determined by two factors: How long you own and use the property as a rental, and which depreciation method you use.
There are different depreciation methods that give different amounts. Any one of them can be used to determine the amount you can deduct each year. But the most common one for residential rental properties is the Modified Accelerated Cost Recovery System (MACRS). Normally, MACRS is used for any residential rental property placed in service after 1986. By using this method, the expense of buying and improving a rental property is spread out over 27.5 years, which is what the IRS considers to be the “useful life” of a rental house.
To compute how much your depreciation should be each year, you’ll need to figure out your basis in the property or the amount you paid for it. You may also be able to include some of your settlement fees, legal fees, title insurance, and other costs paid at the settlement. This number is a bit complicated since there is a need to separate the cost of the land from the building since only the rental house itself – and not the land it is built on – can be depreciated. For the most part, you can use property tax values to help figure out how much of the purchase price should be designated for the house, or your accountant might elect to use a standard percentage.
When you’ve arrived at the amount designated for the rental house alone, you’ll have to do one more task— to figure out your adjusted basis. You can increase the basis in a rental property to account for things like major improvements or additions, money spent restoring extensive damage, or the cost of connecting the property to local utility service providers. The basis can decrease, too, in the event of insurance payments you received to cover theft or damage and any casualty losses you took a deduction for already that were not covered by your insurance. Starting with your adjusted basis, you can now calculate the amount of depreciation you can deduct on your income tax return.
Depreciation of a rental property is a valuable tool for investors looking to reduce their annual tax obligation. But things are more complicated since rental property tax laws can be complex and change quite a bit now and then. Because of this, it’s best to work with a qualified tax accountant to ensure that depreciation is being calculated and applied correctly.
When you hire Real Property Management Baton Rouge, we can link you with accounting professionals who can help you answer all your depreciation questions and more. Teaming up with our experts can help property owners make sure that there are no unpleasant surprises when tax time comes. Don’t hesitate to contact us online or give us a ring at 225-389-6860 to know more about what our Baton Rouge property management services can do for you.
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