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Tax Talk with George Saenz

Ask the tax adviser

Rental property depreciation

Dear Tax Talk:
I have a rental residential property and I need to calculate the depreciation on it. What is the formula for figuring depreciation? Thanks very much,

Dear Jonathan:
It seems this week I got more questions on depreciation than I get all year, so I picked yours to give an example.

Depreciation is a tax deduction intended to recover the cost of your investment that generates income. Since most real property appreciates, it seems contrary to allow a deduction for depreciation. But think of depreciation as cost recovery and it might make more sense.

That said, reduce the cost of your real property by the value of the land since land is not depreciable. If you don't know how much the value of the land is, use a ratio such as you might find on your real property tax bill. Or, if you can't find a ratio, use 5 percent to 20 percent of the cost.

Since you have residential rental property, you need to find its useful life for tax purposes. Useful life or recovery period is the period over which you will recover your cost using the Modified Accelerated Cost Recovery System or MACRS (pronounced makers) that applies to most depreciable assets since 1986. Most property located in the United States is depreciated under the General Depreciation System.

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For residential rental real estate, the recovery period is 27.5 years as you might well find if you reach page 29 of IRS Publication 946. Real property is depreciated the same amount every year except the first year, when your depreciation depends on the month you acquire the property or place it in service. For example, say you bought a condo in January but improved it until June when you listed it for rent. You then had a tenant move there in September, but it is considered placed in service in June when it was available for rent. Table A-6 on page 69 of Publication 946 provides that for property placed in service in the sixth month of the year you multiply your cost by 1.97 percent to determine your recovery deduction.

For example, if the condo cost $100,000 of which $5,000 is land and you made $15,000 in improvements plus installed $5,000 in appliances, your depreciable building cost is $110,000 ($100-5+15). You calculate the appliance depreciation over a different recovery period. Page 27 of Publication 946 tells you that appliances are five-year assets. Table A-1 on page 67 gives you the percentages for five-year assets, which in the first year is 20 percent. Therefore, your depreciation deduction is $3,167 reported on Form 4562 as follows:

$110,000 x 1.97 percent = $2,167 Line 19h
$5,000 x 20.00 percent = $1,000 Line 19b

-- Posted: March 27, 2003

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See Also
Tax pros and cons of rental property
Depreciating a rental property

Property swaps can save tax dollars

Tax glossary
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