How Depreciation of Rental Property Affect Your Taxes

Depreciation of rental property is often overlooked but it makes a big impact on your taxes. Learn how if affects your rental property tax... and capital gains tax.

RELATED: How to Calculate Depreciation of Rental Property

How Does Depreciation Affect Rental Property Tax?

Short answer: Depreciation lowers your rental property tax.

Landlords can claim rental property depreciation as tax deductions. This is a big deal since depreciation will be one of your largest tax deductions, which means it will play a big part in trimming your rental property tax.

To better understand the relationship between depreciation and rental property tax, just take a look at the tax formula below:

Rental Property Tax = (Rental Income - Rental Expense - Depreciation) x Tax Rate

The IRS only allows you to claim depreciation as a tax deduction for investment properties (e.g. rental properties). Home owner cannot claim tax deductions for their personal residences (unless it meets the definition of a home office).

In case you didn't claim depreciation tax deductions for your past tax filings, no worries you're still allowed to include up to 3 years worth of depreciation in the next one.

Does Depreciation Affect Capital Gains Tax Too?

Short answer: Yes - Depreciation of rental property raises your capital gains tax

When you sell a rental property, you're required to pay capital gains tax on the profits. See for the formula for capital gains tax below:

Capital Gains Tax = (Capital Gains x Tax Rate) + (Depreciation x 25%)

Rental property depreciation increases your capital gains tax in 2 ways:

  1. It increases the your capital gains (taxable profit) - Since your profits have increased, you will end up more tax overall - For more details, See our guide on selling rental property.

  2. Depreciation recapture - This is the part that in red above. Basically you're required to pay back 25% of all depreciation that you have claimed so far.

If you're interested in learning more about depreciation, you can look up "Unrecaptured section 1250 gain" on the IRS website.

Rental Property Accounting