Depreciation Rules

Depreciation, also referred to as cost recovery, is an incentive provided by the tax rules to encourage real estate investment.  It’s a non-cash deduction which first goes to shelter a rental property’s cash flow and principal reduction from income tax.  If there is leftover depreciation, it can be used (within certain limits) to shelter your income from other sources such as your salary. 

(While most people can use the loss from their rental property to shelter income you should keep in mind that the timing of if/when the losses can be used is subject to something called the Passive Loss Rules.)

Depreciation is a terrific benefit but unfortunately most real estate investors are not getting the biggest bang for their depreciation buck.  Here’s why:

Most rental properties are made up of at least four different categories of assets:  land, building, personal property and land improvements.  Each of these four asset categories is depreciated over a different number of years.  Here’s a quick overview:

1.  Land is not depreciable.

2.  Personal property (stove, refrigerator, washer, dryer, carpeting, drapes, etc.) in a residential rental property is depreciated over 5 years.

3.  Building depreciation falls into two separate categories:
    a.  Residential rental buildings (rental houses, apartment buildings, etc.) are depreciated over 27.5 years.
    b.  Non-residential rental buildings (shopping centers, office buildings, etc) are depreciated over 39 years.                                

4.  Land improvements (parking lot, driveway, landscaping, fences, etc.) are depreciated over 15 years.

The tax rules prescribe different depreciation percentages for each year.  Here are the percentages for the first two years: ( for complete details refer to my Audio Seminars ).
   
              

                                                                                                                                                                    
Be sure to allocate your cost among these four categories: land, personal property, building and land improvements.  This is called bifurcating (which means to divide).  You should become a lean, mean bifurcating machine!

Click here to learn more about bifurcating.

 

 

 

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