Real estate investing can provide a number of benefits to investors. One of these potential benefits is annual depreciation. The IRS allows investors to deduct depreciation as an expense once a property is placed into service. Because no asset lasts forever, depreciation is meant to capture the wear and tear of the property on an annual basis.
Depending on the asset, the amount of depreciation that can be deducted each year will vary. There are different depreciation systems but in the US, investors use the Modified Accelerated Cost Recovery System (MACRS) or straight-line depreciation. Some example depreciation schedules are listed below for different types of assets:
- Appliance, carpeting, furniture: 5 years
- Furniture and equipment: 7 years
- Fences and roads: 15 years
Residential and commercial properties are also different asset classes, at least according to depreciation. It’s important to know that land cannot be depreciated — only the structure on the land.
Residential Investment Property
According to the IRS, residential property has a shorter useful life than commercial property. Investors can deduct 3.636% (1/27.5) each year for 27.5 years of the property’s value.
As an example, an investor buys a property for $500,000. The tax assessment values the land at $50,000 and the structure at $450,000.
Below is an example for calculating the depreciation schedule:
$450,000 x 3.636% = $16,362/yr
The above example has been simplified since we don’t include the cost basis. Investors should add any closing cost to the purchase price to get the cost basis.
From the above example, if you have owned the property for five years, you can deduct $16,362 x 5 = $81,810. Upon selling the property, you may have to pay depreciation recapture.
If the first year of ownership is not an entire year, then the investor will take only partial depreciation for that period. After that, full-year depreciation can be taken.
There are limits to the amount of depreciation that investors can expense each year. For those with a modified adjusted gross income of $100,000 or less, the IRS allows up to $25,000 in depreciation expense. For incomes up to $150,000, the expense is tapered. For those with an income over $150,000, depreciation expense is not allowed.
Commercial Investment Property
Commercial real estate (CRE) properties follow the same types of depreciation deduction as residential, except that their useful life is longer. Instead of 27.5 years, CRE properties use 39 years. That’s equivalent to 2.56% per year.
For example, if the cost basis of a property is $525,000, annual depreciation will equal $13,440 per year. Generally, a real estate tax accountant will keep track of the depreciation schedule for an investor’s property.
You can read more about how to depreciate property from IRS Publication 946.
By working with a real estate accountant, you can ensure that you are utilizing the right depreciation calculations and schedule.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The income stream and depreciation schedule for any investment property may affect the property owner's income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. Examples shown are hypothetical and for illustrative purposes only.
