How do I calculate depreciation?
Depreciation is a deduction taken over several years. You generally depreciate the cost of business property that has a useful life of more than a year, but gradually wears out, or loses its value due to wear and tear, weather damage, etc. To figure out the depreciation on your rental property:
- Determine your cost or other tax basis for the property.
- Allocate that cost to the different types of property included in your rental (such as land, buildings, so on).
- Calculate depreciation for each property type based on the methods, rates and useful lives specified by the IRS.
1. Determine Your Cost Basis
Your cost basis in the property is generally the amount that you paid for the property (your acquisition cost plus any expenses), including any money you borrowed to buy the place.
If you are converting your property from personal use to rental use, your tax basis in the property is calculated differently. Your basis is the lower of these two:
- Your acquisition cost
- The fair market value at the time of conversion from personal to rental use
If the property was given to you or if you inherited it, or if you traded another property for the current property, there are special rules for determining your tax basis in your rental property. If you were given the property, for example, your basis is generally the same as the basis of the generous soul who gave it to you; if you inherited it, your basis is generally the property's value on the day the previous owner died. Special rules apply to property inherited from people who died in 2010.) Consult IRS Publication 551: Basis of Assets for more information about these situations.
2. Allocate the Cost by Type of Property
After determining the cost or other tax basis for the rental property as a whole, you must allocate the basis amount among the various types of property you're renting. When we speak of types of property, we refer to certain components of your rental, such as the land, the building itself, any furniture or appliances you provide with the rental, etc.
If your rental is a condo or other property that shares property within a community, you're deemed to own a portion of that property. A portion of the land and a portion of the purchase price must be allocated to the land on which the building sits.
Why this effort to divide your tax basis between property types? They are each depreciated using different rules and different lives.
3. Calculate the Depreciation for Each Type of Property
Here are the most common divisions of tax basis for a rental property, followed by explanations of the different methods of depreciation that generally apply:
|Type of Property
||Method of Depreciation
||Useful Life in Years
|Residential rental real estate (buildings or structures and structural components)
|Nonresidential rental real estate
|Shrubbery, fences, etc.
||150% declining balance
|Furniture or appliances
||200% declining balance
In straight-line depreciation, the cost basis is spread evenly over the tax life of the property. For example:
A residential rental building with a cost basis of $150,000 would generate depreciation of $5,455 per year ($150,000 / 27.5 years).
In the year that the rental is first placed in service (rented), your deduction is prorated based on the number of months that the property is rented or held out for rent, with 1/2 month for the first month. If the building in the example above is placed in service in August, you can take a deduction for 4½ months' worth of depreciation, amounting to $2,046 ($5,455 x 4.5/12).
Declining Balance Depreciation
This kind of depreciation is calculated by multiplying the rate, 150% or 200%, by the straight-line depreciation calculated based on the adjusted balance of the property at the start of the year over the remaining life of the property. To make matters somewhat easier, the IRS and others publish tables of percentages that can be applied to the original cost to determine yearly depreciation. For instance, here's the 200% declining balance table for five-year property:
The 200% declining balance depreciation on $2,400 worth of furniture used in a rental would be $461 in Year 3 ($2,400 x 19.20%).
Tables for all types of properties can be found in IRS Publication 946: How to Depreciate Property. For general information on depreciation of rentals, see IRS Publication 527: Residential Rental Property.