For real estate investors, the benefits that come from depreciation on your tax deductions means more liquidity for you. This can be a huge positive, as even though the property may be getting older, its worth to you isn’t necessarily decreased. Even still, you can claim tax deductions that reduce what you’re spending out of pocket, keeping your returns high.
Every fiscal year, you get to reassess the value of your depreciation and claim it as a tax deduction. This means less spent on taxes for you. Maximizing your depreciation deductions might seem complex, but with a few simple steps, you can significantly reduce your expenses.
Here’s what you should know.
Almost any property can claim depreciation deductions
It may come as a pleasant surprise to some real estate investors, but your investment property does not need to be new—or like-new—to rake in the deduction value of a depreciated property. You can continue to deduct until the value of the entire property has been exhausted, or until you no longer use the property as an income-generating investment.
If you cease renting or decide to sell the property, it will no longer be eligible for deductions on your taxes.
Depreciation deductions are available whenever a rental property is
As soon as you prepare a rental unit for your renters, you can start calculating deductible depreciation rates. This algorithm is based on property, recovery period, and the specifics of whichever depreciation method you happen to use.
You need to separate the value of the land from the building(s), as well as any adjustments that must be made before the property is able to go up for rent. Then, you can use depreciation tables to calculate the exact rate and tax benefits you are eligible for when your property is available to rent.
As soon as your property is ready for the market—even if it waits vacant for some time—you can calculate depreciation and deduct it from your yearly tax commitment.
Renovations can come with new depreciation-eligible assets
Through depreciation claims on your taxes, you can spread out the cost of improvements to the property after purchase through delayed taxation. Every new asset you add will come with deductions you can itemize on your yearly tax report. This makes low-interest rates and refinancing for improvements even more exciting since you can potentially stand to gain back your investment in a quicker amount of time.
Be sure that the renovation items you add increase the base value of your property for at least a year, however. Anything less than that, and the added value will not be deemed worthy of tax deduction.
There are two primary depreciation systems
When it comes down to calculating your exact deductible depreciation amount, you will use one of two systems. For the vast majority of investors, this will be the General Depreciation System (GDS). In much rarer circumstances, such as when a property is tax-exempt or has qualified business use less than half of the time, then you will use the Alternative Depreciation System (ADS).
The GDS uses a recovery period of 27.5 years for residential property. Each year, this depreciation equates to 3.636%, with partial years becoming a fraction of that percentage.
The ADS, on the other hand, uses a recovery period of 30 years. Because of the longer schedule, the yearly deductions are smaller than with GDS deductions. This is ideal since most real estate investors will hold their properties for shorter periods of time and will be restricted to a GDS system, anyway.
The Bottom Line
Speaking with a real estate finance or tax professional can help you get the most out of GDS deductions, but understanding these systems and the ways in which depreciation can be applied to your rental investments will come in handy during tax time.
Create a depreciation schedule, speak with a financial consultant, and make the most of your investment property through the tax deductions possible through depreciation.
Legal disclosure: Information on this website and blogs does not involve the rendering of personalized investment advice. A professional advisor should be consulted before implementing any of the options presented or discussed. No content should be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
For more on real estate investment and property management, contact 208.properties today.