Depreciation is a topic that is not properly discussed in the real estate market. Investors have no idea how they can use depreciation to have tax relaxation. Here we are describing the basics of depreciation and how investors can calculate it to enjoy its advantages.
Rental property depreciation
In general terms, depreciation is the loss of value of a property over time, due to wear and tear. Rental properties also lose their value, so it applies to them as well. To maintain their value owners, have to keep them updated.
Rental property depreciation is when owners deduct the cost of maintenance and repair to restore the value of the property and keep it desirable on the rental listing. Depreciation returns the deduction over the lifespan of the property, instead of taking a single major tax break. The timeline to return depreciation is called the recovery period. The length of this period depends on the type of property and its purchasing value.
The recovery period for residential units can be 27 years and for commercial buildings and properties, it’s 38 years. A property depreciation calculator is used to calculate the recovery period.
How does property depreciation work?
To get tax deductions, you need to prove that your property is useful and purposeful. The IRS is responsible to approve these deductions. If you convince authorities that you qualify for the tax breaks, you can calculate depreciation for your property, or the rental property whatever the case is.
How to report to the IRS?
To report your property to the IRS you need to fill out a form, which is commonly known as an E form. In special circumstances, you may need other forms. You can get information from the appropriate authorities.
For rental properties, it is very important to understand that you have to mention your rental income. If you are using it as a primary residence and renting it out for less than 15 days, it will be an exceptional case. In this situation, you will not be able to deduct rental expenses from taxes. A rental property depreciation calculator can help you to calculate the money you can deduct.
When to calculate rental property depreciation?
Landlords claim depreciation as it saves money, particularly for rental properties. You can maximize your profit and reduce your Taxes. All these reasons are very attractive for investors and they choose to calculate the depreciation of rental properties. You need to calculate it before you rent out your property. When your property will be listed and tenants will be there, you will be able to claim depreciation, so calculations beforehand are very important. The depreciation calculator can help you in this regard.
Calculation of depreciation for rental property
Firstly, you need to know if you qualify for depreciation or not. Certain conditions are necessary to meet.
Ownership: To qualify for depreciation, you should be the owner of the property.
Income source: This rental property must be a source of income for you.
Usefulness: It is also very important to prove the usefulness of property. Moreover, the usefulness of the property must be more than a year. If you use it for rent for less than a year, it will not qualify for depreciation.
If you meet the criteria, you can calculate depreciation. For that, you need to calculate the overall cost. This cost will be divided by the lifespan of the property. In the end, you will calculate your depreciation schedule. Here we are discussing these steps in detail.
Calculate overall cost
To calculate the overall cost, you need to add all the costs like property value, closing cost, etc. For rental properties, the purchase price of the listing is the property value. However, if you have converted it to a rental property later, you may need to hire an appraisal to calculate property value. Closing costs may include property taxes, utility service charges, legal fees, transfer taxes, surveys, and a fee of a real estate agent.
Divide cost by lifespan
The overall cost you have already calculated will be divided by the years for which your property will have a useful life. For properties, the lifespan is usually 27.5 years, approximately.
Depreciation schedule
Depreciation can be calculated only if the property is useful. You cannot calculate depreciation before listing it, no matter when you purchased it. You can file a claim after it is rented out.
Rental property depreciation recapture
When an investor claims depreciation for property and later decides to sell it, deprecation occurs. If the property is sold, you have to pay additional taxes according to the requirements of the IRS. Depreciation recapture calculators can help you to calculate these taxes which you have to pay. So, it is very important to research all the costs before you sell your investment property.
How to find an appropriate rental property
Investors use depreciation calculators, but many other platforms are also available which can determine the profitability of a specific property for the investors. You can easily find these tools online. These real estate calculators can help to calculate the profit for any property you want to invest in. It will be easier for you to calculate the estimated cash flow. However, find a tool that has reliable sources of data and good analytic tools.
It is very easy to use these tools, instead of working on spreadsheets. Moreover, they can integrate different tools for you, for instance, these tools consider your interest rate, property tax, and repair costs as well. You can easily palm your budget and get rid of many financial problems.
You will have a comprehensive rental strategy and will have a clear picture of the short-term and long-term profits. You can compare different properties and see which is more suitable for you. A wide range of data is available on these platforms which include, Cash on cash return, cap rate, cash flow, rental income, etc. However, make sure you are using a reliable tool or online platform for this purpose. Old data will not be able to provide desired results.
If you’d like to talk more about property management, or you need help with Everest Property Management, please contact us at Everest Realty.
As a top producing Realtor and Property Manager; Terry specializes in sales, extensive construction homes, rentals, REO’s, short sales, and all aspects of Real Estate. After graduating the University of Michigan with a master in MBA, Terry continued his endeavor and now has over 15+ years of experience in the Real Estate world. If there is anything that has to do with Real Estate and sales, you can always be sure of Terry to provide important, specialized knowledge.
