What Is A Rental Property Depreciation Limit?
If you own a rental property, here's what you need to know about rental property depreciation before filing your next tax return.
Rental property owners can deduct the price of the property through rental property depreciation deductions. In this post, we’ll tell you everything you need to know about rental property depreciation, including what the limits are, a special allowance for owners that meet certain income limits, how to calculate depreciation, and how cost segregation can impact depreciation deductions.
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What Is A Rental Property Depreciation Limit? The Quick Answer
The Internal Revenue Service allows property owners to depreciate the value of an investment rental property over 27.5 years using the Modified Accelerated Cost Recovery System (MACRS). This applies to all properties put into service on or after January 1, 1987.
What Is The Rental Property Depreciation Income Limit?
Rental property owners can calculate and claim depreciation regardless of income. However, there is a special allowance available to certain property owners that can be used to offset real estate activity losses.
This rule applies to property owners who actively participate in real estate activity, including activities like approving tenants and setting rental terms. Active participants can deduct up to $25,000 of rental real estate losses each year if they have a modified adjusted gross income (MAGI) of $100,000 or less.
This allowance begins phasing out for taxpayers who earn $100,000, and the allowance is phased out completely for taxpayers with MAGI that exceeds $150,000.
However, there are no limitations on rental property owners who are considered real estate professionals based on guidelines set by the IRS.
How To Calculate Depreciation On Rental Property
There are two methods used for calculating depreciation for a rental property. The General Depreciation System (GDS) is what most rental property owners will use. The other method, the Alternative Depreciation System (ADS), is used when a property meets certain requirements (such as being used primarily for farming). For this section, we’ll be focusing solely on calculating depreciation using the GDS method.
Using GDS, a property owner can deduct up to 3.636% of the property’s initial cost basis per year. The initial cost basis is the value of the property minus the value of the land since land can’t be depreciated.
If the property isn’t put into service for a full year, the first year’s depreciation will look a little different. If, for example, the property is purchased and put into service in July, the full 3.636% will not be deducted in the first year. The IRS breaks it down as follows:
After the first year, you’ll use 3.636% through the useful life of the property — 27.5 years.
While this seems simple on the surface, there are special considerations that may affect the depreciation of your property. If you sell a property at a higher price than it was purchased for, you may be subject to depreciation recapture. We recommend speaking with an accountant or a tax preparer to discuss your unique situation and to get the most out of depreciation and other expenses for your rental properties.
How To Report Rental Property Depreciation
The rental property depreciation expense is reported on Schedule E, which is filed with your federal income tax return. It may also be reported on Form 8825 for multi-member LLCs, partnerships, and S Corps. However, you should discuss how to report depreciation based on your tax situation with an accountant or tax preparer.
Cost Segregation For Rental Property
As previously discussed, you can use the straight-line depreciation method — writing off the same amount each year for 27.5 years. However, you may also use a tax strategy called cost segregation to accelerate depreciation.
Straight-line depreciation looks at the building as a whole. With cost segregation, building components are assessed and categorized to be written off over a shorter period of five, seven, or 15 years. For rental properties, things like carpeting, furniture, and appliances can be depreciated over five years.
Cost segregation frontloads depreciation, reducing your tax liability and, in some cases, even resulting in a refund, especially if bonus depreciation is claimed. To take advantage of this tax benefit, you must have a cost segregation study performed on your property. During this study, assets will be assessed and categorized, so they can be written off over a shorter period.
Fortunately, most cost segregation companies offer a free analysis that not only determines the fee required to complete the study but can also give you an estimate of potential tax benefits. If you’re interested in potentially saving thousands on your next return, know what to look for in a cost segregation company and start with the options on our list of the best cost segregation services.