As a new landlord, you're probably wondering how you can use tax deductions to save money on your rental property. To do this, you will use your rental property depreciation.
If this is new to you, keep reading to find out what rental property depreciation means and how it can help you save money on your tax return.
What does rental property depreciation mean?
Rental property depreciation is used in doing your taxes as a landlord. It essentially accounts for how much of your property's value is being used up over time. In terms of taxes, it allows you, the landlord, to deduct the costs of buying the property and fixing it up from your taxes over the property's useful life. This lowers your taxable income and helps you save money.
Think of it this way: You could get one large tax deduction the year you buy, fix up and list your rental property. Or, using depreciation, you could take that large deduction and spread it out over the course of your property's useful lifetime. Each year, you'll get a slightly larger deduction, which should help cover some repair costs not covered by rent.
There are a few important things to know about rental property depreciation:
- A property starts depreciating as soon as it becomes available to renters. If you own properties that are still being rehabbed and are not available for rent, then they are not depreciating yet. Before buying a property, keep in mind how long it will take to rehab it. That could affect how your taxes are done depending on when you buy the property and when it is listed as available.
- As a rule of thumb, you can expect your property to depreciate at a value of 3.636% for 27.5 years, according to Investopedia.
- The value of the building can depreciate, but the land cannot. This is important to remember when you have a building that is sitting on valuable land, such as land near the ocean or in a desirable area.
How does rental property depreciation work?
First off, you can use rental property depreciation if your property meets four simple guidelines, as determined by the Internal Revenue Service (IRS). You need to be the owner of the property and use it in your business, either as an office or, mostly likely for a landlord, as an income-producing source. The building also needs to have a determinable useful life, meaning that just like your favorite shirt, it will age, decay, become obsolete, get used up or lose its value naturally. Finally, the property needs to be in use. If it's in disposed or unused, then it cannot be deducted. So long as you meet this criteria, then your property can qualify for depreciation.
Depreciation starts when the property becomes available. That means that if you list your property on June 1 but don't start renting it until September 1, then your depreciation date is still June 1. You didn't have a tenant, but the property was still available. If the tenant then moves out the following year on September 1 and you make repairs before renting it again on November 1, then you can still claim depreciation. The property was still in use, but it was "idle."
You must stop depreciating the property when:
- You have finally deducted the entire cost of the property, usually after that 27.5 years.
- You stop using it as an income-producing property. This can happen by selling it, converting it to person use, abandon it altogether or destroy it.
Calculating rental property depreciation
This is something you will want to work with a tax account to determine correctly for your property, but in general, here's how to calculate rental property depreciation:
- Establish the property's basis: The basis is how you paid for the property. Did you pay in cash? Take out a mortgage? Some combination of the two? You can sometimes include some back taxes and fees the seller made you pay. Check with your tax accountant to be sure.
- Identify the cost of the building separate from the land: Again, the land and building value are considered separate for tax purposes. You can do this by using the fair market value at the time you bought your property, or you can use the assessed real estate tax values. If you bought a property for $100,000 and the fair market value was $90,000, with $80,000 for the building and 10% for the land, the you can determine that 90% of your purchase was for the building, and the remaining 10% is for the land.
- Determine the cost of the building: The new cost of your building is actually $90,000, with $10,000 paid for the land.
- Add in any adjustments: The cost of your building might go up from $90,000 if you have made substantial improvements, such as rehabbing the bathrooms or adding on an addition or replacing the roof. Some legal fees and work needed to bring up the building to code can also increase the basis. Deductions from the basis include any insurance payments you received that resulted from damage, theft or anything else covered by insurance.
A tax accountant will be able to help you calculate your rental property depreciation based on your exact case.
How a property management company can help you with your taxes
Many new landlords think they can handle the work of doing home repairs and collecting rent from tenants on their own, and in some cases, they're right. Some landlords have a lot of experience with home repairs and can do the work themselves, and they just ask their tenants to send their monthly rent via PayPal or other money sending app. But how many landlords go through the hassle of doing their own taxes even when they just own the one property where they live?
This is where a property management company like Atlas Lane can shine. In addition to finding and vetting tenants, taking care of property repairs and collecting rent, our property asset managers also keep track of all the information that you will need for your tax documents. While we won't do your taxes for you, we can ensure that you won't be up late trying to research what you need to file on the internet. Our managers keep track of all relevant documents to make filing your taxes easier, and they can answer questions or point you in the direction of a tax expert who can help. At the end of the year, we'll send you all the tax documents you'll need to complete your annual filing.
Don't lose money on your rental property because you missed some tax documents. Learn more here about how Atlas Lane can make tax filing much easier.