Rental investment properties tend to come with benefits when tax time rolls around. When it comes to purchasing real estate properties for investment purposes, it is important for investors to understand the tax benefits and laws which will affect your particular situation.
What is Depreciation?
A key tax deduction available to rental property owners is something called depreciation. Unlike most of your run of the mill tax benefits, this one works in a very particular manner. Instead of being a one-off tax deduction that you receive when you purchase or put money into a property, depreciation works over time. Allowing a property owner to deduct the costs associated with purchasing, maintaining, and improving the property through the course of several years.
What Does Useful Years Mean?
The years you are able to deduct the depreciation costs is referred to as the “useful years” of the property. The classification of a useful year is essentially the amount of years the asset is to remain in service. These years are estimated by the Internal Revenue Service based on current trends and are approximated to last for as long as the property or asset is still profitable. The useful years are estimated to expire when the property will likely require major repairs or stop producing efficient results.
Do You Qualify for the Depreciation Deduction?
When it comes to tax deductions and benefits, it can be hard to understand what you qualify for and what you don’t without the help of a professional. However, knowing if you qualify for a depreciation deduction is actually reasonably straightforward.
Here are the qualifiers for the depreciation deduction:
- You own a property.
- The property is used by you as an income-generator or business prospect.
- You can determine a useful life period.
- This life expectancy is approximated to last longer than a one-year period.
In other words, if you own a property—even if it’s financed—and you are collecting a rental payment from said property that will be expected to last for more than a year but not indefinitely, you qualify.
These qualifiers do not apply to property that is land-only, however, as land does not wear out or decay like a man-made structure does. This also means you cannot claim a deduction for landscaping, clearing, or planting on said-land. As these are included in the cost of owning a land-only property.
How Long Can You Claim Depreciation?
Depreciation begins when the property is able to be placed in service. While you may think this means the period in which you place a tenant in the home, it actually refers to when the property is ready to be rented. Confused? Let’s break this down.
Say you purchase the property at the beginning of the year—January 15th. The property requires several months of renovations before it is able to be lived in. Taking you until April 1st. You take your time screening tenants. But do not secure a tenant until the end of May, with their lease starting June 15th.
While you may think your depreciation claims do not start until June 15th, as that’s when the property is rented, your claims actually start on April 1st, when the property was able to be rented out. If the property is ready to be put into service, even if there are short periods of idle activity (meaning not generating an income) the property can collect the depreciation deduction. Depreciation can be taken on properties based on a 27.5 year schedule.
What this Means to You
Depreciation is a useful tool for anyone getting involved in the rental investment property industry. It allows a property owner to reduce their annual tax obligation. It does so by spreading out the cost of purchasing the property over an extended period of time. However, tax laws can change frequently, so always work with a qualified tax accountant to ensure you’re meeting all of your tax responsibilities.
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