Real estate depreciation is a process of deduction, which takes place over the useful life of your property. Depreciation spreads out your property tax deduction, instead of taking the entire amount in the same year as purchasing the property. But, when it comes to depreciating assets, residential real estate is subject to different rules and guidelines than commercial property.
When you buy a piece of residential property or any other asset, it shows a loss on your accounting books. By depreciating assets, you distribute the taxable cost of that property across its useful life. Learn everything you need to know about depreciating residential property assets for the 2020 tax season.
Depreciating Assets for Real Property Owners: Residential Real Estate
A common misunderstanding is that depreciating assets relate to the process of wear-and-tear that property experiences over time. This might be true in principle, but it is not a practical way in which to think of real estate depreciation. Depreciating assets, for residential real property or commercial property, is about the cost – not the overall value of the real estate.
So, your property might be in spotless near-new condition, but you can still depreciate it – and you should. Depreciation is a method of showing a legitimate loss, instead of automatically showing taxable income.
Does My Property Qualify for Depreciation?
If you own a residential piece of real estate that is not used for business or as a means of income, it doesn’t qualify for depreciation. Both commercial property and real property can qualify for depreciation if it meets some requirements. The IRS sets the guidelines for qualifying depreciable real estate.
As just expressed – the overarching rule-of-thumb is that your real property must be an income-producing asset, or directly involved in your business. Depreciation, also, only applies to assets that have a determined useful life. Depreciable assets, therefore, wear-out, degrade, get consumed, or decay over time. So, when thinking about depreciable real estate, it does not apply to the land on which your real property is built.
A depreciable asset has a useful life of over a year. Expenditures on assets, with a useful life of less than one-year – like replaceable air filters or toilet paper – do not qualify for depreciation. Depreciation is only applicable to expenses associated with real estate additions and renovations.
In order to claim depreciation on residential real property, you must be the owner. Let’s say, theoretically, your property was recently acquired and there is outstanding property tax debt. Whoever is on the hook for debt associated with the property is the owner – and can claim depreciation on what would otherwise be taxable income.
Additional Stipulations on Depreciating Assets for Real Estate
The timeline for depreciating real property begins the year that the property goes into service under your name. It must remain in-service for over a year to qualify for depreciation. And, since you cannot depreciate the land, when you purchase a new property, make sure to separate the land from the building.
What Asset Expenditures are Depreciable for Residential Real Property?
When it comes to residential real estate, there are several places to start depreciating assets. The first, and most obvious is the initial purchase cost. Whereas commercial real estate has a useful life of 39 years, residential real property is depreciated over 27.5 years.
In addition to the cost basis of the property, depreciation applies to property improvements and equipment, as well. Property improvements can be anything which: increases the property’s value or usefulness; restores the property to its original or near-original usefulness, or adapts the property to accommodate new functions.
Adding a porch or covered garage to a residential property increases its usefulness. Replacing rooting support beams or wall-to-wall carpeting restores the property to a like-new state. And, upgrading outdated wiring to account for your usage requirements is an adaptation to the property’s original functionality.
Depreciating assets for real property can be applied to a wide range of expenditures. But, janitorial services and other regular maintenance does not qualify. Depreciation is only applicable to expenses on improvements to the value of your property – not general maintenance and upkeep.
For example, fixing some worn tile on the floor is a general repair. But, replacing the entire tile floor should be depreciated. The expense to fix a broken roof is claimed in the same year it occurs, but a new roof is a depreciable asset.
Getting Help with Real Estate Depreciation
Once you start looking at the value of depreciating assets, you can begin to see opportunities for business growth in places you never knew to look at. Real property depreciation is just one of many avenues for increasing your financial prudence to pursue with a tax advisor. There are financial opportunities all over the place – if you know where to look.
If you are ready to take a look at depreciating assets, associated with your residential real property, get a free consultation with an accountant. And, share this article on social media to help spread the word about financial tax solutions for business.