Rental properties can be efficient investment options and may provide significant tax deductions. Among the most significant of these deductions is for the depreciation of the property as a capital asset. There are many forms of property that can be rented, but for purposes of this article, the discussion is limited to rental housing.
How to Compute Depreciation for Taxes
1. Determine the type of property. In order to be eligible for depreciation, a property must be owned by the person seeking the deduction, must be used for an income-producing activity, and must have a usable life of over a year. Consequently, one cannot sublet a property and claim depreciation expense.
2. Find the useful life. The useful life is used to determine the number of years over which the depreciation expense is spread. For purposes of residential properties, the Internal Revenue Service uses a 27.5 year useful life. The number of years assigned as the useful life for other types of property may vary greatly from this. Consequently, it is very important to research IRS documents for the useful life for other forms of property. Also, land cannot be depreciated.
3. Compute the annual depreciation expense. Annual depreciation expense is computed by dividing the purchase price of the property by the useful life. Consequently, if one were to sum the annual depreciation expense for the entire useful life, it will equal the total amount of the purchase price of the property.
4. Reduce earnings by depreciation expense. The depreciation expense is useful to reduce taxes because it is deducted from revenues (as are other expenses) when one computes the net income on which taxes are applied. For example if a house were rented for $10,000 per year and the depreciation expense were $3,000 (in combination with other expenses), then the net income would be $7,000. Consequently, $3,000 of revenue would not be subject to tax in that year because of the depreciation expense.
- Taxes and deductions associated with rental properties can be very complicated. It is wise to consult a tax expert.
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