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George Saenz, the Tax Talk columnistReal estate depreciation demystified

Dear Tax Talk,
Can you explain the formula used for depreciation purposes on a rental property? We lived in the condo for 10 years and now are renting it out. Original cost was $53,100 and current fair market value is $101,000. What is used as the base and how do I figure my deduction? Thanks much!
-- Steve

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Dear Steve,
One of the deductions you can claim on a rental property is an allowance for depreciation or cost recovery. Although, as you can see, most real property does not depreciate in value, you can claim an allowance for your cost that helps you reduce the income on which you pay taxes.

Depreciation for residential rental is computed on the straight-line basis over 27.5 years using the midmonth convention in the first year. Straight line is 1 divided by 27.5 (3.636 percent) multiplied by the tax basis. Midmonth means you get half a month's depreciation for the month the property is put to rental use. So, if you put the property out for rental in June, you'll claim 6.5 months divided by 12 months in the first year (6.5/12 x 3.636 percent = 1.969 percent).

When you convert personal-use property to business use, your tax basis for computing depreciation is the lower of its cost or value. Since the cost in your case is lower, you'll use this as your tax basis. You're only allowed to claim depreciation on the building aspect of the property and not on the land portion.

Hence, you'll need to assign a value to the building and land. This can be done by looking at the relative value of each, such as from a property tax bill. Suppose your property tax bill shows an assessed value of $100,000 combined, and that land is $15,000 of this amount, you would claim depreciation on 85 percent of the $53,100 cost. If you sell the property within three years of moving out, you can still claim the home-sale exclusion but will have to pay tax on the depreciation you claim. If you don't sell within three years, the appreciation (currently approximately $50,000) will become taxable upon a later sale.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.'s corrections policy -- Posted: April 18, 2006
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