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Depreciation - Depreciation Real Estate
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Depreciation is the loss in value of an asset / building over
time due to wear and tear, physical deterioration and age. The
cost of reproducing an income property can be recovered over the
useful life of the asset which is determined by law.
Depreciation is treated as an expense and is a line item on an
income statement. Depreciation can only be applied to the building
and not the land, since land does not wear out over time.
Residential income property must be depreciated over a 27.5 year
period using straight line depreciation. Commercial income
property must be depreciated over 39 years using straight line
depreciation. Straight line depreciation stipulates that an
asset must be depreciated by equal amounts each year over its useful
life.
Example: You purchase a warehouse for $900,000. The land
where the warehouse resides is valued at $120,000. The
building is valued at $780,000. Current law allows you to
depreciate commercial properties by equal amounts annually over 39
years. Your depreciation deduction for the first year is based
on the mid month convention. The day of the month that you
purchase the property doesn't matter. You can only deduct half of the first months
depreciation. If you put the warehouse into service on June 1, you are
allowed to deduct 6 and 1/2 months of depreciation for the first
year. |
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| 780,000 |
| ----------- = $20,000 |
| 39 |
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20,000 |
| First Year Depreciation = 6.5 X ( --------- ) = $10,833 |
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Accountants calculate a full year of depreciation for the above warehouse
(commercial properties) by multiplying 2.56 % times 780,000 which
equals 19968. A full year of depreciation for residential
income properties would be calculated by multiplying 3.64 % times
the building basis. The depreciation deductions that you write-off
in any year reduce your taxable income thus increasing your profit
for that year.
The real estate income property investor is also allowed to
depreciate capital improvements such as a new roof or an addition to
a building.
Example: You have owned the above warehouse for about 7 years
now and it is in need of a new roof. The cost of the new roof is
$19,500. You are allowed to depreciate the cost of the roof
over 39 years. If you put the new roof on in July, you are
allowed to deduct 5 and 1/2 months of depreciation in the first year. |
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| 19,500 |
| --------- = $500 |
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| 500 |
| First Year Depreciation (roof) = 5.5 X ( ------ ) = $229 |
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Accountants would calculate
a full year of depreciation for the roof by multiplying 2.56 % times $19,500
which equals 499. Note that land improvements can be
depreciated over a 15 year period using 150 declining balance.
Land improvements include walking paths and trails, fences,
landscaping, sprinkler systems, retaining walls, fountains, etc. All depreciation amounts that you write-off in
each year for the building and capital improvements reduce your
adjusted basis for the property thus increasing the taxable profit
you must declare when you sell.
The On Target income property analysis software helps you determine
the impact of depreciation on a property's rental income and
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depreciation on the potential sales proceeds from an income
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©
Copyright 2000 - 2013 Advantage Software LLC |
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