How to Calculate Rental Property Depreciation in 2024

Real Estate Investing5 min read

A must read for real estate investors come tax season.

Johnpaul Moses
Johnpaul Moses

If you own a rental property like me, you’re likely eligible to take a depreciation deduction on your taxes each year.

This deduction can save you a significant amount of money on your tax bill each year … but how does depreciation work for a rental property?

How do you calculate it?

Are there any deductions when you’re talking about rental property depreciation? 

Don’t worry; we’ve got you covered with answers for all these questions and much more!

Here’s everything you need to know about rental property depreciation and how to calculate it. 

What Is Rental Property Depreciation? 

Depreciation is a tax deduction that rental property owners can take each year.

The depreciation deduction accounts for the natural wear and tear on a property over time, as well as a potential loss of value as the market fluctuates. 

Depreciation happens over a period of 27.5 years. Each year in that period, you’ll deduct a percentage of the building’s value from your taxable income based on your calculations.

It’s important to note that depreciation is calculated based on the value of the building, not the value of the land.

After the 27.5 year period is over, owners can no longer take depreciation deductions on the property.

The 27.5 years starts over when the property is sold to a new owner. 

Got it? 

You can also take depreciation deductions for major upgrades to your property. For example, if you put a new roof on your property or updated the appliances, you would be able to take a depreciation deduction for these improvements.

Depreciation periods for these items vary—for example, appliances depreciate over a period of five years. 

Depreciable Property Requirements

In order to qualify for a rental property depreciation deduction, you’ll need to meet specific requirements set out by the IRS. The qualifications for this deduction are: 

  • You must own the property you are taking the deduction for. 
  • You must use the property for a business or income-producing activity. Rental properties qualify for depreciation deductions, but a property you live in does not. 
  • It must have a determinable useful life. The standard useful life for residential buildings is 27.5 years, and the standard for commercial buildings is 39 years. You will calculate depreciation rates using this time frame, even if your property lasts for much longer. 
  • The property must be held for at least a year. You cannot claim rental property depreciation on your taxes if you own a property for less than 12 months. 

If your property does not meet these standards, you cannot take the rental property depreciation deduction. 

Tax Deductions 

Deductions help you reduce your total taxable income. When calculating your taxes, you will subtract the deductible amount from your yearly income before calculating taxes owed. 

Rental property depreciation is a sizeable deduction for most landlords, so it’s important to include on your taxes if you qualify for it.

This is just one of many deductions that you as a landlord can take as part of your taxes. 

How to Calculate Rental Property Depreciation Step by Step 

Here’s a step-by-step look at how to calculate your rental property depreciation: 

Step 1: Calculate your property’s cost basis.

Your cost basis is the value of the building and any qualifying closing costs, minus the value of the land it sits on.

For example, if you bought a property with a land value of $75,000, a total value of $500,000, and qualifying closing costs of $5,000, your cost basis would be $430,000: (500,000 + 5,000) – 75,000

Step 2: Identify your annual depreciation rate.

Properties put into service after 1986 can use the General Depreciation System as part of the Modified Accelerated Cost Recovery System.

This means that you can calculate depreciation by dividing your cost basis by the recovery period, which is 27.5 years for residential buildings.

For residential buildings, this comes out to a rate of 3.6% per year.

If your property was put into service before 1986, you may need to use an alternative depreciation rate. It’s best to consult a real estate tax expert in this scenario. 

Step 3: Calculate your depreciation amount for the year.

Once you know your depreciation rate, you can calculate your total deduction amount for the year.

For example, if you have a residential property with a cost basis of 200,000, you can deduct $7,200 on your tax return.

If you have owned the property for less than a year, you will need to adjust your deduction for monthly depreciation.

The IRS has helpful resources online for calculating monthly depreciation rates. 

Rental Property Depreciation FAQs 

Still have questions?

Don’t worry: next, we’ll take a look at some of the most commonly asked questions associated with rental property depreciation. 

Q. Do You Have To Pay Back Depreciation on Rental Property? 

You will have to pay back rental property depreciation when the property is sold — this process is called recapturing.

When the property is sold and you receive the payout from the property, you will need to pay your regular income tax rate on the amount equivalent to your depreciation deductions. This rate is capped at 25%. 

For example, if you sold a property for $500,000 and had taken $25,000 in depreciation deductions over the years, $25,000 of the profit would be taxed at your normal tax rate, while the remaining $475,000 would be subject to a lower capital gains tax. 

Many real estate investors will use a 1031 exchange to avoid depreciation recapture and other taxes when selling a property. A 1031 exchange essentially allows you to swap one property for another of similar value. 

Q. What IRS Form Is for Depreciation of Rental Property? 

When deducting depreciation for your rental property, you’ll fill out IRS form 4562.

If you use online tax preparing software, this will help you calculate depreciation as well. 

Q. What Date Do You Start Depreciating a Property After You Purchase It? 

Depreciation doesn’t start immediately after you purchase a property.

Instead, it starts after you put the property into use for your business.

For rental properties, this means you can start depreciation when you start renting out the property. 

The Bottom Line: Rental Property Depreciation 

Don’t skip your rental property depreciation deductions when filing your taxes this year—they could save you a significant amount of money.

Don’t hesitate to seek help from a tax professional to ensure you’re correctly maximizing your tax deductions. 

 

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