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What
is Rental Property
Depreciation
and How do You Calculate it? PART 1
If
you own or manage rental properties, it's important to know how to
calculate your rental property depreciation and to make use of it to
claim your tax deductions. Our step by step guide in plain English will
help you understand this technical term effortlessly.
What
Exactly is Rental Property Depreciation?
As
the building and structures of your rental property will suffer from
wear and tear
over the years, it will gradually fall in value and has a limited
useful lifespan. This steady drop in value
over the useful lifespan of your rental property is labelled as
depreciation.
When claiming your property tax deductions, remember you can only
include depreciation for your investment or rental property. You are
not allowed to claim depreciation as a rental expense for your own
home.
It is important to know only the building and physical
structures of your rental property can be depreciated. The land
which your rental home sits on and its open areas do not wear out over
time so you cannot include them as rental property depreciation.
How
to Calculate Your Rental Property Depreciation
While the
formula for calculating depreciation
comes in a few flavours, the straight line depreciation method is most
commonly applied for rental properties:
Annual Depreciation = (Purchase
Price - Land Value) / Useful Life Span (in years)
Annual
Depreciation - Amount of depreciation expenses that you
can
claim every year.
Purchase Price
- Total price you paid for your rental property.
Useful
Life Span - Total number of productive years for your
rental property. Your local tax laws will state a fixed number or give
you clear
instructions on how to calculate it.
Let's have an example to see this formula in action:
Terry just bought a new rental home for $235,000 and the
land is valued at $50,000. Residential rental property in his country
is depreciated over 30 years. How much is his depreciation?
Annual Depreciation = (235,000 - 50,000) / 30
= $6166.67
A
quick and easy
shortcut to calculating your rental property depreciation is to use a
property management software with top notch accounting
features. They will be especially helpful if you are new to accounting
or own multiple rental
properties.
Buildium
is an online property management program that is highly recommended by
landlords for its easy and fully automated accounting
features. It
also comes with a complete
database to store your important tenant and property information.
If
you want a more powerful program that will allow you to carry out
detailed accounting easily and generate helpful reports on
your
rental revenues, then you should consider the popular LandlordMax
instead. Click
here if you want to compare both software to see which one
will work better for you.
If You Own
Residential Rental Property in the U.S.
If
your rental building or home in the U.S. earns at least 80% of its
revenue from units that are rented out, then you have a residential
rental property. Hotels and motels are not considered as residential
rental property.
Residential rental property is depreciated
using the Modified Accelerated Cost Recovery System (MACRS) by General
Depreciation System (GDS).
Don't worry about the ugly
techncial terms - All you have to know is that you will be using the
same depreciation formula given above with a useful life span of 27.5
years.
For the first year
that you own your rental property, you will only be able to claim a
partial depreciation and the total amount will depend on which month
you bought it:
Partial
Depreciation Percent for Year 1
| Month |
Depreciation
Percent |
| January |
3.485% |
| February |
3.182% |
| March |
2.879% |
| April |
2.576% |
| May |
2.273% |
| June |
1.970% |
| July |
1.667% |
| August |
1.364% |
| September |
1.061% |
| October |
0.758% |
| November |
0.455% |
| December |
0.152% |
Let's
say you bought your rental home for $180,000 in April and the land
alone is valued at $50,000. How much is your depreciation for the first year?
Depreciation
for Year 1 = (Purchase Price - Land Value) x 2.576% (in yellow)
= (180,000 - 50,000) x 0.02576
Now
that you know how to calculate your rental property depreciation, it's
time for you to move on to something even more important - How
depreciation plays in a crucial role in your rental property taxes and
sales:
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