Businesses get a deduction for anything purchased for legitimate business operations or business assets. Business assets come in many forms and therefore are delineated into several categories. Their depreciation lives are dependent on what the IRS considers its useful life.
Learn everything you need to know about depreciating real estate that qualifies as real property.
The Easy Guide to Understand Depreciating Real Estate in 2020
Whether, it’s a residence, business, or rental property – real estate offers a tax deduction in every year of its useful life. When looking at depreciating real estate assets, whether residential or commercial, you can only expense the infrastructure – not the land. So, in the context of depreciating real estate, it does not apply to the land on which your building is built.
You have to determine the value of your property’s infrastructure, as opposed to the land it occupies. One way to determine the land value vs property value is to have a professional come and perform an appraisal on the property. Another method is to separate the value of the land value by getting a copy of your properties’ most recent tax assessment report. Depreciating assets are expensed as an equal deduction over each year of the property’s useful life.
Understanding the Benefits of Depreciating Real Estate
But, why should you care about understanding how real estate depreciates over time? Because you may be missing out on well-deserved deductions. For example…
On the grand-opening day for a newly constructed office building, the real estate asset is in the best condition of its useful life. Nothing has been used, so everything is brand new and in pristine condition – representing the highest value it will ever hold.
On the second day, you spill coffee on the brand new carpeting. In the second year, the roof begins leaking – you get the picture. So, for a set number of years, depreciation incrementally decreases your taxable income from the capital expenditure for real estate.
You continue to depreciate the real estate, annually, until the cost basis is depreciated in full or legal ownership of the asset changes hands. The IRS lays out the timelines for depreciating assets of different types. When it comes to real estate depreciation, the IRS guidelines and stipulations identify two different types of real estate: commercial, and residential real estate.
Depreciating Commercial Real Estate Property
The IRS stipulates that commercial real estate holds a useful life of 39 years. So, your depreciating expense becomes the cost basis of your asset, divided by 39. When it comes to claiming depreciation on your property, commercial property is depreciated differently than residential properties.
To claim depreciation on, either commercial or residential real estate, the property must be producing income or used for a business purpose. And, any income it accrues must be taxable by the IRS. One of the ways to accelerate depreciation is to claim 179 deductions.
179 deductions let you claim depreciation on pieces of property – without claiming depreciation on the entire value of the property. This means that you can claim a deduction for the capital expenditure to fix that leaky roof on your commercial or residential office building. The purpose of a 179 deduction is to expense an asset immediately.
The most common mistake is not knowing how to split the land and building deductions properly. A percent of the overall cost of a building must go to land. An easy way to assess it is to go to a county assessor’s office. The property tax bill always separates the value of the land from the building.
Real Estate Tax Tip for 2020: Qualified Improvement Properties
The 2020 CARES Act fixes an oversight that was left-over in the Trump Tax Cuts, keeping businesses from being able to depreciate interior renovations to nonresidential real estate. These interior improvements are called Qualified Improvement Properties. The new rules state that Qualified Improvement Properties that went into service as of 2018 depreciate over a 15-year timeline.
Think about that for a second – your real estate depreciates over 15-years – instead of 39. That means you claim your expense twice fast! On top of the faster depreciation, Qualified Improvement Property can be fully expensed in the first year using the 179 deductions. This means a roof improvement that costs you $100,000 that would have been expensed for 39 years is now deductible in the year you fixed your roof.
Getting Help with Real Estate Depreciation
You have to understand depreciation to build strategic financial solutions over the long-term of your business. In the end, the benefit is having more control over your expenses, income, and revenue reports at the end of the fiscal year. The rules regarding bonus depreciation and 179 deductions recently changed to the benefit of businesses, and now you understand more about how it affects your business.
If you need guidance on depreciating real estate or claiming your commercial property expenses, get a free consultation with an accountant. And, keep your eyes open for the follow up to this resource, regarding residential real estate depreciation.