Depreciation of Rental Property
for Residential Landlords

Depreciation of rental property is truly one of the great financial benefits for residential landlords. It's kind of like being able to "have your cake and eat it" so to speak. Rental real estate is one of the few investments that allow the financial golden nugget of depreciation to be utilized. Let's take a look at what depreciation is, what its benefits are, and how it's applied to residential rental property.

Basically, depreciation is a method for business owners to recover the cost of their income producing property to account for it "wearing out" over time. The cost is recovered through yearly tax deductions that are spread out over a specific "recovery period" which depends on the property's class or category.

For residential rental property, the recovery period is 27.5 years. The amount of yearly depreciation deductions that you can take depends on the property's basis (or cost), the recovery period, and the depreciation method used.

Benefits from Depreciation of Rental Property

Depreciating your rental property can significantly lower your tax bill by reducing your taxable income. Even though your rental property may be "appreciating" in market value over time, in the eyes of the IRS, it is considered to be depreciating in value and wearing out because it is classified as income-producing property.

Because of this, using the depreciation deduction can make a rental property show a "paper loss" even though the property may actually be producing a positive income for its owner. This paper loss can be used to reduce other forms of taxable income, such as wages, etc. It's a wonderful benefit that very few other investments offer.

How Depreciation of Rental Property is Applied

Residential rental property is made up of the following components:

• Raw Land (cannot depreciate)
• Improvements to the Land (15 year property) - Driveways, landscaping, fences, etc.
• The Building (27.5 year property)
• Personal Property (5 year property) - Stoves, refrigerators, carpets, etc.

All of the above items (except for the raw land) can be depreciated each year and their combined total deducted from taxable income. For residential rental property, raw land cannot be depreciated because it doesn't physically "wear out".

So, when figuring depreciation, the cost of the raw land must be determined and subtracted from the cost basis of the entire property.

In addition, the cost basis of the land improvements and personal property should be depreciated separately (from the building) using Form 4562 (Depreciation and Amortization) and then combined with the depreciation of the building. This is because personal property and land improvements have shorter recovery periods (5 and 15 yrs) than the building (27.5 yrs). The result will be a higher combined depreciation deduction versus depreciating the entire cost basis over 27.5 years.

Please note: The above information on depreciation of rental property is general in nature and should not be considered tax or accounting advice. It should not be relied upon for your own particular circumstances. For tax advice, please consult the services of a qualified accountant or tax attorney.

For more in-depth information and examples on depreciation of rental property, please visit The Landlord's Library book collection. It's a fabulous "one-stop" resource for helping you pave the path to your landlording success.

Return from Depreciation of Rental Property to
Federal Income Tax Filing