Can You Depreciate Inherited Property?

Investors can take advantage of tax deductions by using depreciation on their investment properties. Depreciation is available for residential and commercial real estate owners who use their properties for business or income-producing means.

The IRS has strict regulations on calculating depreciation and using depreciation when filing federal taxes. Learn how to calculate your depreciation and if you can use it on inherited property.

What Is Depreciation?

In the investment property context, depreciation refers to the asset’s cost over the duration it is useful. It does not refer to how long it will last but how long it will remain beneficial to an investor or business. Depreciation doesn’t have to be related to the monetary value of the asset over time.

Assets like real estate wear down over time, and the IRS allows taxpayers to take deductions from their ordinary income to account for depreciation. The IRS depreciates commercial properties and residential real estate on a straight-line basis.

The depreciation excludes the value of the land. Depreciation over 27.5 years is allowed for residential real estate, while commercial properties depreciate over a 39-year basis. The IRS has strict rules for depreciation that you must follow to benefit from the tax deduction.

How Investors Use Depreciation

Investors use depreciation to deduct the cost of a property during its useful life from their taxes. Depreciation is a way to deduct the purchase price and the cost of improvements of their investment properties. An investor who owns a residential real estate property can determine their depreciation by dividing the purchase price of their property, minus the land value, by the IRS’ set number of years.

For example, a residential real estate property purchased for $1,000,000 with a land value of $150,000 would base its depreciation on $850,000. Since residential properties depreciate on a basis of 27.5 years, the $850,00 would be divided by 27.5 for an annual deduction of $30,909 available.

Investors can also calculate depreciation by multiplying the value of their property, minus the land, by 3.636%. Commercial property owners would divide their value by 39 to find their annual tax deduction.

Is Depreciation Allowed on Inherited Property?

The depreciation process is different if you inherit a property rather than purchase it. You must meet specific requirements for depreciation, including:

Property use requirements

You must use the inherited property for an income-producing activity or business. This includes using it as a rental property. If the inherited property is used for business and personal use, you can only use the percentage of business use to calculate depreciation.

Basis

Basis is the term for the monetary amount to depreciate and is calculated using fair market value for the property on the date of the decedent’s death. The basis can be located on a tax return or estate tax form. Value can also be assessed through other reasonable methods if a tax return is unavailable.

Depreciation Periods

The period for depreciation begins when the property is ready for business use, not when you start using the property. You can determine the depreciation amount by the property type provided by the IRS.

Cost of Improvements

Inheritance depreciation also includes the cost of improvements made to the property. To calculate inheritance depreciation, add the cost of improvements made between the date of inheritance and the date you began using it for your business to the base amount.