Landlords get to write off their expenses much like any other business. Certain expenses, however, have to be written off over a number of years. This article explains how to depreciate rental property and what are some of the common questions landlords face.
What is Depreciation?
Say something for your business costs you $1,000. If it can be expensed, you will deduct $1,000 from your taxable income in the tax year of the expense. If it must be depreciated over five years, you will deduct approximately $200 from your income in each of the next five years.
Which Expenses Get Depreciated?
The general rule of thumb is to ask whether you’re making something better than it was before. “Better” means you can’t expense the whole amount in one year and must depreciate it over several years instead. For instance, if your front porch is falling off the house and you prop up the existing wood and add some screws, that’s a repair that can be expensed. If you tear down the old porch and build a new one that will last for 20 years, that’s an improvement that must be depreciated.
Do I have to Depreciate Even Tiny Improvements?
No. Create a written policy, and sign and date it, stating that it’s your policy that small improvements (e.g., less than $100) will be expensed. The amount is arbitrary, although it must be subject to reasonableness. A $1,000 limit is probably too high for most small time landlords.
What Determines the Time Period of Depreciation?
Properties are grouped according to classes that have similar useful lives. For rental property, there are only a few kinds of property classes that matter:
- 5 years: appliances, cabinets, carpets, office computers
- 7 years: everything else not listed
- 15 years: landscaping
- 27.5 years: residential buildings, and things permanently attached to them
Pay attention to the last class, which includes “things permanently attached” to residential real estate. If you build a new interior wall, you need to depreciate that over 27.5 years because that wall is permanently attached. The same assumption gets made about plumbing and electrical improvements.
Cabinets, carpets, and other furnishings rented with an apartment are not permanently attached. These can be depreciated over the special period of only 5 years.
For landscaping, which includes shrubs and bushes, you need to use 15 years. For everything else, including tools, use 7 years.
I just bought a new house and the appliances where included in the purchase price. Do they get depreciated over 27.5 years, too?
No, you can estimate fair market value or replacement cost to create a basis for these properties, then remove that basis from the house basis and depreciate your appliances over the normal 5 year period.
What’s the Formula for Depreciation?
There are tables that take 100% and divide by roughly the number of years of depreciation. But it’s not that simple because the IRS wants to manipulative timing of purchases. For instance, it would be advantageous to take an entire year’s depreciation for a property purchased and put into service in December. This is not allowed. The result is that you need to know when you started using the depreciable property. A property placed into service in December will have almost no depreciation for its first year, and the balance of that first year’s depreciation will be allowed in the final year of the property’s useful life. Service dates are usually tied to months or quarters.
You also get to choose whether you’re using “straight line” depreciation or accelerated depreciation. Straight line is easy to calculate and has another advantage. Unlike some accelerated schemes, straight line depreciation will never cause you to pay the alternative minimum tax [link].
What tools are available to help me simplify my depreciation calculation?
You can always hire an accountant to do the math for you. Members at MassLandlords.net also get access to a free spreadsheet that helps you do it yourself.