Building Riches: Depreciation in Real Estate Tax Savings

When you acquire a rental property, the IRS allows you to spread the cost of the property over its useful life, reducing your taxable income—a benefit known as the depreciation deduction. This deduction is one of the most significant advantages in real estate, helping you retain more rental income instead of paying it in taxes.

Which Properties Can Be Depreciated?

Residential Rental Property

• Examples: Houses, apartments, condominiums, etc.

• Depreciation Period: 27.5 years using the Modified Accelerated Cost Recovery System (MACRS).

Commercial Rental Property

• Examples: Office buildings, retail spaces, warehouses, etc.

• Depreciation Period: 39 years under MACRS.

Improvements

• Description: Permanent alterations such as landscaping, fences, driveways, and certain renovations.

• Note: The depreciation period may vary based on the type and classification of the improvement.

Furnishings and Appliances

• Scope: Items in furnished rental units like furniture, appliances, carpets, etc.

• Depreciation: These items are depreciated separately from the building and usually have shorter depreciation periods.

Note: Land cannot be depreciated due to its indefinite useful life, making it a non-depreciable asset.

Key Considerations

Date Placed in Service

• Depreciation Start Date: Begins on the date the property is put into service (i.e., when it becomes available for rent).

• Strategy: Placing the property in service early in the tax year can maximize your deductions by allowing for a full year’s depreciation.

Cost Segregation Study

A cost segregation study is an effective tool for optimizing depreciation deductions by reclassifying assets into shorter depreciation periods. Here's how it works:

1. Identification of Components:

   • Specialists inspect the property to identify shorter-lived assets such as electrical systems, plumbing, flooring, specialized lighting, or certain architectural features.

2. Categorization and Analysis:

   • Each component is analyzed based on its characteristics and function, using construction documents, blueprints, and records to determine cost and lifespan.

3. Reclassification:

   • Assets categorized as personal property or land improvements are reclassified for shorter depreciation periods (usually 5, 7, or 15 years) compared to the standard 27.5 or 39 years.

4. Detailed Report:

   • Findings are compiled into a comprehensive report that details the reclassified assets, their costs, and the recommended shorter depreciation periods. This report is crucial for IRS compliance.

Benefits of a Cost Segregation Study:

• Newly constructed properties

• Renovated or expanded buildings

• Properties acquired from previous owners

• Properties with substantial construction costs

Note: Expertise is crucial; ensure the study is conducted by experienced professionals to maintain accuracy and IRS compliance.

Take Advantage of Special Depreciation Allowances

Our experienced professionals can help you optimize your deductions and take full advantage of special depreciation allowances. Stay ahead of the latest tax changes with expert advice from Deer Park CPA.