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Rental property depreciation

George SaenzDear Tax Talk,
We bought a beach house in 2001 that is being used as a rental property. What are the advantages and disadvantages of depreciation? We have heard about recapture and are wondering what effect that will have on us down the road if we sell rather than do a tax-free exchange. -- Arlene

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Dear Arlene,
Depreciation is an annual allowance that helps you recover on your taxes the cost of the property. Generally, real property never depreciates in value, but since the investment in the property generates income, the tax law allows you to recover your costs against that income through annual depreciation deductions.

For residential rental property, the cost is recovered over 27.5 years. Only the cost of the structure is allowed as a depreciation deduction; the value of the land cannot be depreciated. This means you need to assign a value to the land and reduce the cost of the property by that amount to figure your depreciation deductions.

One of the principal advantages of depreciation is that it is a current tax deduction at your prevailing marginal tax rate, and later when recaptured in the case of real property, it is taxed at a maximum of 25 percent. Recapture of depreciation deductions occurs in the year you sell the property. If you exchange the property in a tax-free exchange, there is no recapture until the exchange property is sold.

Depreciation is not optional on a rental property. You should claim the full amount you're entitled to claim, since it is subject to recapture whether or not you claim it.

-- Posted: Feb. 6, 2002




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