Use this calculator to estimate the annual depreciation deduction for your residential rental property. Depreciation allows you to recover the cost of income-producing property over its useful life, reducing your taxable income.
Understanding Rental Property Depreciation
Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over the time you use the property. For rental properties, this is a significant tax benefit, as it reduces your taxable rental income without being an out-of-pocket expense.
What Can Be Depreciated?
Generally, you can depreciate the cost of buildings and other improvements that are part of your rental property. However, land itself is never depreciable because it is not considered to wear out, become obsolete, or get used up. Therefore, when calculating depreciation, you must separate the value of the land from the value of the building.
Key Components of Depreciation Calculation:
Cost Basis: This is your original cost of the property, including the purchase price, certain closing costs (like legal fees, title insurance, surveys), and any initial improvements made before the property is placed in service.
Land Value: You must allocate a portion of the total cost to the land. This is often done by using the property tax assessment, an appraisal, or a reasonable estimate based on comparable sales. The land value is subtracted from the total cost basis to arrive at the depreciable basis.
Depreciable Basis: This is the amount you can actually depreciate. It's calculated as: (Purchase Price + Closing Costs + Initial Improvements) - Land Value.
Useful Life: For residential rental properties, the IRS mandates a useful life of 27.5 years. This means you'll spread the depreciation deduction over 27.5 years.
Depreciation Method: The straight-line method is almost exclusively used for residential rental properties. This means you deduct an equal amount each year over the useful life.
Annual Depreciation: This is simply your Depreciable Basis divided by 27.5 years.
First-Year Proration: If you place the property in service during the year (not on January 1st), you can only claim depreciation for the months it was available for rent. The first year's depreciation is prorated based on the number of months the property was in service.
Example Calculation:
Let's say you purchased a rental property for $300,000, incurred $5,000 in closing costs, and spent $10,000 on initial improvements. You estimate the land value to be 20% of the total cost, and you placed the property in service on July 15th, 2023.