Investment in rental property has emerged a beneficial financial decision. A rental property can be a stable source of earning for beginners. One can reap tax benefits as well on the rental property benefits. You can cut the rental expenditures from the earning of rental income thus bringing down your tax liability. Meanwhile, the other important tax deduction meant for depreciation works in a different way. Depreciation can be defined as a process which is used for deducting the expenditure of purchasing and renovating a rental property. Instead of taking a single deduction in the year you buy or renovate the property, depreciation distributes deduction throughout the life of the property. Given below are the factors how depreciation for residential rental property works:
1. Which Property is Depreciable?
You must find out first which property is depreciable. As per the rules of IRS, you can depreciate the property if:
- You are the owner of the property even if it is liable to a debt.
- You are using it for any income-generating act or business purpose.
- Property has got a determined useful life and loses its worth as a result of natural factors.
- The property may last for more than a year.
2. When Will Depreciation Start?
When a property falls in the category of service or is ready to use as a rental property, you can apply depreciation deductions. You may continue to depreciate the property until any one of the conditions mentioned below are met:
- If you have deducted all the cost or other bases in the concerned property
- You leave the property from service even if you could not recover the entire cost or other bases. The property will be retired from service the moment it is not being used as an income-generating property. When you destroy it, convert it or leave it, the property will be retired from service. The property report will provide more information regarding when the property may be retired from service.
There are three factors that will help you decide the amount of depreciation you will be able to deduct every year. These methods are the basis in the property, recovery period, and depreciation method.
Given below are the basic steps:
- Determine basis of the property: Basis of the property is the cost of the property or money you shelled out in cash or mortgage to buy it. Settlement fees, closing costs which may include legal fees, transfer taxes, etc. are included in the basis.
- Separate land cost and buildings: You can only depreciate the cost of building and not land, so you must calculate the value of each to depreciate the exact amount. You may require the help of experts to prepare a rental property depreciation report.
- Decide your basis in the house: When you find out the basis of the property and value of the house, you will be able to find out your basis in the house.
- Decide adjusted basis if required: There are possibilities that you may need to make an increase or decrease to your basis for some occasions. The occasions may take place between the times when you purchase the property until it is ready to be rented.
Depreciation has emerged as a useful method in case you invest in rental properties. It distributes the cost of acquiring the property in the coming years and brings down every year’s tax liability. However, rental property laws witness frequent changes. Therefore, you must work with an expert tax accountant when building, operating or selling your rental property. They will also explain all of the important details of depreciation residential rental property which will prove extremely helpful.