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Depreciation for Rental Property

Updated on January 12, 2024
Article byRishab Nigam
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Depreciation For Rental Property?

The depreciation of 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 costs and could be used to write off the taxes. And therefore, it helps in lowering taxes.

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The depreciation on the rental property offers a 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.

Depreciation For Rental Property Explained

Depreciation for rental property offers huge tax advantage, thereby making the real estate investments profitable for investors. The depreciation can be regarded as a non-cash expense that helps write off tax expenses, and it is an easier way to record the asset’s cost on the income statement.

When an owner purchases a real estate property, they have to work on improvement as days pass by. This helps them to keep the property in a sound condition so that it is of good value even after years of depreciation for rental property. Through this method, the owners get an opportunity to claim tax benefits for the expenses incurred for improvement.

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 having sustainable positive cash flows. The rental property can be utilized for both sustainable cash flows in rent, and enhanced 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 rises in value. It makes liability of taxes as it is an expense that covers the cost of an asset and improves the rental property.

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How To Calculate?

To calculate the value of IRS depreciation for rental property, 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

Moving forward, there are a few elements that need to be computed first for the formula to work better. Let us have a look at them below:

  • Calculate cost basis of depreciation for rental property

The first thing is to figure out the cost of the real estate property. Cost basis is the difference between the property value and the value of the land the property stands on plus closing costs (depreciating).

  • Depreciation expense of the property in question

This is the amount that is calculated by dividing the cost basis amount by the years of rental property depreciation, which, according to the IRS, is 27.5 years. These years mark the useful life of the property.

Rules and Requirements

The IRS lists down a few rules that make depreciation for a rental property work for a property owner. Some of them have been mentioned as follows:

Examples

Below are some examples explained in detail.

Example #1

Let us take the example of residential property. The cost basis of rental property is $325,000. Per the IRS guidelines, it is assumed that the residential property would have a useful life of 27.5 years. 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, helps 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 commercial property. The cost basis of rental property is $340,000. Per the IRS guidelines, it is assumed that the residential property would have a useful life of 39 years. A straight-line depreciation method helps 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.

Advantages

Depreciation for rental property Is easy to calculate and with the guidelines provided by the IRS, the requirements related to the type of real estate properties that are eligible for these benefits, are clearer. The merits of this method have been mentioned below:

Disadvantages

Besides the benefits that helps property owners know how the method can enable them make profits, there are multiple demerits too that one must be aware of. Listed below are some of them. Let us have a quick look at them:

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