What Landlords Need to Know About Depreciation and Property Value

Key Takeaways

• Depreciation is a powerful tax benefit that helps rental property owners reduce taxable income and increase long-term cash flow.
• Knowing the IRS rules, such as eligibility requirements, recovery periods, and depreciation methods, is essential for maximizing deductions.
• Fall River Property Management helps investors apply depreciation correctly, stay compliant with IRS guidelines, and make the most of their rental property’s financial potential.

Depreciation is one of the most valuable tax benefits available to rental property owners. It allows investors to reduce taxable income by accounting for the natural wear and tear that occurs over time.

By properly claiming depreciation, landlords can significantly improve their cash flow and protect long-term returns.

Fall River Property Management helps investors understand and apply these rules correctly so they can take full advantage of the deductions available while staying compliant with IRS guidelines.

If you’re not leveraging depreciation on your rental property, you may be missing out on substantial savings. Keep reading to learn more!

Eligibility Criteria for Rental Property Depreciation

• Ownership: To be eligible, you must own the property outright, even if it carries a mortgage. You cannot claim depreciation on a property you are leasing, subletting, or renting.
• Income-producing: The property must be used for an income-producing activity or a business. Personal residences and vacation homes are not eligible for depreciation. However, if you convert your personal home to a rental, you can start depreciating it from the date it becomes available for rent.
• Determinable useful life: The property must be something that can wear out, get used up, decay, or become obsolete with time. It should also have a determinable useful life; that is, the period over which it is expected to produce income before it wears out completely.
• Cannot be bare land: The property must have at least one or more permanent structures. Bare land cannot be depreciated because it does not have a determinable useful life.

How to Depreciate a Rental Property

Depreciation begins on a property’s “Placed in Service” Date. The “Placed in Service” Date is when the rental property becomes available for rent, even if it is temporarily vacant. This date does not necessarily coincide with its date of purchase.

The IRS uses the Modified Accelerated Cost Recovery System (MACRS) as its standard method for depreciating rental properties. Under the MACRS, properties may be assigned a recovery period of 27.5 years or 30 years. The recovery period of a rental property is the number of years over which you can depreciate its cost.

There are two distinct systems for depreciating different types of properties in the MACRS. For most properties, the General Depreciation System (GDS) is used.

For other types of properties, the Alternative Depreciation System (ADS) may apply. Property owners can elect to use either of the two systems; however, that decision is irreversible. It cannot be changed throughout the useful life of the property.

Which depreciation system is right for your rental property to ensure long-term cash flow?

General Depreciation System (GDS)

This is the accepted method for most rental properties. Unless the property owner elects to use ADS or it is required, this method will be automatically applied to the property. Under GDS, a rental property is assigned a recovery period of 27.5 years (330 months). Because it assigns a shorter recovery period, this system has the advantage of faster cost recovery.

Alternative Depreciation System (ADS)

This method assigns a recovery period of 30 years or 40 years if the “Placed in Service” Date is before Dec. 31, 2017. This longer recovery period is suitable for some property types because of the smaller annual deductions. Properties under the following categories are usually depreciated using the Alternative Depreciation System:

• Properties that are used mostly outside the U.S.
• Properties financed with tax-exempt bonds.
• Properties used by income-generating activities that are tax-exempt.
• Buildings with a qualifying business that is used 50% of the time or less.
• Properties that are used mostly for farming.
• Properties owned by certain categories of business entities, such as a REIT.
• Properties used by foreign persons or entities not subject to U.S. income taxes.

How to Calculate Depreciation on Your Rental Property

To calculate depreciation on your rental property, use the following four-part process.

Determine Your Total Cost Basis

This is the purchase price of your property plus certain capitalized costs (legal fees, abstract fees, recording fees, transfer taxes, surveys, title insurance, utility installation fees, etc.)

It also includes debts owed by the seller that you agree to pay (back taxes, interest, recording or mortgage fees). Total costs include capital improvements made to the property before or after putting it in service.

Calculate Your Depreciable Basis

Since land does not wear out and it has an indefinite useful life, it is not considered a depreciable asset. The value of the land must be deducted from the total cost basis of the rental.

To determine the value of the land use property tax assessment ratios from your local tax assessor's office or a third-party appraisal from an MAI-designated appraiser. This step gives you the property’s depreciable basis.

Determine the Recovery Period

Based on the General Depreciation System (GDS), this is 27.5 years for residential rental properties and 39 years for commercial properties.

Calculate the Annual Depreciation

To calculate annual depreciation, using the straight-line method, divide the depreciable basis of the property by the recovery period. Alternatively, you can use the rate set by the IRS as the annual depreciation rate for rental properties, which is 3.636%. Multiply the value of your property by 3,636% to know how much you can claim as a deduction on your annual tax return.

Bottom Line

When calculating depreciation, it’s essential to understand the difference between repairs and improvements, as misclassifying these can impact your deductions. You’ll also want to be mindful of depreciation recapture, which can lead to unexpected tax obligations when you sell the property.

Partnering with a qualified tax accountant and a knowledgeable team like Fall River Property Management ensures you’re claiming depreciation correctly, maximizing your savings, and avoiding costly mistakes.

With the right guidance, you can confidently leverage depreciation to strengthen your rental property’s financial performance. Contact us today!