Investing in a rental property in Pahrump, NV, offers several financial advantages, with rental property depreciation being one of the most impactful. This IRS-approved deduction allows you to recover the cost of your residential rental property over time, reducing taxable income and increasing cash flow. Understanding how to calculate rental property depreciation correctly is essential for protecting your rental property investment and optimizing long-term returns.
What Is Rental Property Depreciation?
Depreciation is the process of deducting the cost basis of a real property used in an income-producing activity, such as a residential property leased for rent to generate rental income. The IRS considers the wear and tear of the physical structure, even if the property's market value is increasing.
Most rental property owners use the General Depreciation System (GDS) under the Modified Accelerated Cost Recovery System (MACRS). This allows real estate investors like you to claim depreciation deductions over a recovery period of 27.5 years for a residential rental property. These deductions lower your taxable rental income and help you manage your overall tax burden more efficiently by allowing you to calculate the depreciation as a percentage of the original cost over time to reduce the costs required to produce income.
Steps to Calculate Rental Property Depreciation
1. Determine the Cost Basis
Start by determining your property’s cost basis, which includes the purchase price, closing costs, and any capital expenses accumulated before the property is leased.
These may involve:
Legal fees
Transfer taxes
Recording fees
Mortgage fees
Loan origination fees
Certain land preparation costs
Deduct the value of the land to determine your adjusted cost basis, as land is not subject to depreciation.
2. Establish the Depreciable Basis
After subtracting the land value, the remaining amount is your depreciable basis, the portion of the property that can be depreciated. This is the basis for your yearly tax deductions.
3. Select the Appropriate Depreciation Method
You may use the general depreciation system, which spreads the deductions evenly across 27.5 years. However, certain cases may require the alternative depreciation system (ADS), which uses a 40-year recovery period. The ADS may apply to tax-exempt properties or when required by the IRS.
Depreciation under MACRS begins as soon as the property is available for rent.
4. Calculate the Annual Depreciation Deduction
To calculate depreciation, divide the depreciable basis by 27.5. For example, if your cost basis excluding land is $275,000, your annual depreciation deduction would be $10,000. If the property is placed in service mid-year, the IRS requires you to prorate the depreciation expense based on the number of months the property was in use during that first year.
5. Account for Long-Term Tax Consequences
When selling an investment property, the IRS may impose capital gains tax and depreciation recapture tax. These taxes apply to the amount you've previously depreciated and can raise your total capital gains tax liability.
Working with a tax advisor can help you avoid depreciation recapture tax, manage your tax return, and optimize your tax benefits.
Why Depreciation Matters for Your Investment
Claiming depreciation offers multiple advantages:
Reduces rental income subject to taxation
Improves cash flow
Offsets rental expenses
Increases deductions through property depreciation
Enhances return on your real estate investment
As depreciation accumulates over time, your ability to maximize tax benefits grows.
Let Freedom House Property Management Help You Maximize Your Return
At Freedom House Property Management, we understand how important it is to manage every aspect of your rental property wisely, including depreciation. We assist property owners like you from claiming depreciation to complying with Internal Revenue Service guidelines. Contact us today if you want to ensure that you correctly depreciate residential rental property and maximize your investment property.
