Depreciation for Rental Property

What is Depreciation for Rental Property?

The depreciation for the rental property can be termed as the reduction in the rental property value over time due to wear and tear age and deterioration. It is a systematic allocation of cost and could be used to write-off the taxes. and  therefore, helps in lowering of taxes.

Mathematically, one can determine it as the division of cost basis of the rental property with a useful life. The following would be the relationship: –

Depreciation = Cost of the Rental Asset / Useful Life of the Asset

Explanation

Investors invest in a rental property and real estate with the intent of financial planningFinancial PlanningFinancial planning is a structured approach to understanding your current and future financial goals and then taking the necessary measures to accomplish them. Because this does not begin and end in a specific time frame, it is referred to as an ongoing process.read more and to have sustainable positive cashflows. The rental property can be utilized for both sustainable cashflows in the form of rent and enhance equity valueEquity ValueEquity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding.read more as the property rise in value. It makes liability of taxes as it is an expense that covers the cost of an asset and improving the rental property.

How Does it Work?

  • As per the broad rules of Internal revenue service or IRS, the rental properties can be assumed and treated to have a useful life of 27.5 years.
  • To arrive at an effective depreciation value, divide the cost of the rental property with the factor of 27.5.
  • If in case a rental property is in the form of commercial property, then the useful life can be assumed up to 39 years.
  • Land can never be utilized for depreciation; rather, the buildings and properties built on it would be regarded for depreciation.
  • The land is considered to have an infinite useful life.
  • The fair tax assessment helps in the determination of the effective value of the land.
  • The depreciation is valid until the time the individual owns it. Once it sold, the individual can claim depreciation on it.
  • The individual or the owner can start accounting for depreciation once the rental property is ready for the rental business.
Depreciation-on-Rental-Property

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Examples of Depreciation for Rental Property

Below are some examples explained in detail.

Example #1

Let us take the example of the residential property. The cost basis of rental property is $325,000. As per the guidelines of the IRS, it is assumed that the residential property would have a useful life of 27.5 years. Applying a straight-line depreciation methodStraight-line Depreciation MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more, help the owner determine the depreciation on the rental property.

Solution:

Depreciation Example 1
  • = $325,000 / 27.5
  • = $11,818.18

Therefore, the depreciation is $11,818.18.

Example 2

Let us take the example of the commercial property. The cost basis of rental property is $340,000. As per the guidelines of the IRS, it is assumed that the residential property would have a useful life of 39 years. Applying a straight-line depreciation method, help the owner determine the depreciation on the rental property.

Solution:

Depreciation Example 2
  • = $340,000 / 39
  • = $8,717.95

Therefore, the depreciation is $8,717.95.

Depreciation Rules for a rental property

  1. As per the IRS, the individual should own the depreciation property.
  2. The utilization of the property is for business purposes or income generation activity.
  3. There is a determined useful life of the propertyUseful Life Of The PropertyUseful life is the estimated time period for which the asset is expected to be functional and can be put to use for the company’s core operations. It serves as an important input for calculating depreciation for assets which affects the profitability and carrying value of the assets.read more wherein the property is anticipated to have a useful life of more than one year.

Requirements

Advantages

Disadvantages

Conclusion

The depreciation on the rental property offers tax deduction to be claimed under schedule E of the internal revenue service. Therefore, this helps in the proper tax planning of the individual. Once the owner has sold the rental property, he can no longer claim depreciation on the rental property. The depreciation can be regarded as a non-cash expense that helps in write-off tax expense, and it is an easier way to record the cost of the asset on the income statement.

Recommended Articles

This article has been a guide to depreciation for rental property. Here we discuss an example and how does depreciation rules work for a rental property along with advantages and disadvantages. You can learn more about financing from the following articles –