Before we jump into how to maximize rental property tax deductions, let’s take a quick sneak through how real estate depreciation actually works. Simply put, Depreciation refers to the process of subtracting the deductible expenses of buying, modifying, or renovating a rental property. Instead of taking away a lump sum amount in the current year of buying, depreciation shares the deduction along all the useful lifetime of the property.
What might qualify as the possible sources of Rental property depreciation?
The catch in the real estate business lies in spending maximum time as a real estate professional. It implies deducting the complete amount of losses against all passive and non-passive income. To mention a few significant points:
· Local taxes, lawn care, and those insurance are deductible
· Although principal payments are counted as non-deductible, mortgage interests qualify for deductions
· Renovation or vital repairs to the asset are deductible. Hence, property improvements are considered as depreciation expenses.
What does the term Accelerated Depreciation refer to?
The basic rule is that an asset counts the highest in value in the initial phase of its lifespan. It also experiences a significant decline in value over the first few subsequent years. The most important real estate tax benefit of this system involving Accelerated depreciation is that it allows one to take away a higher value of deduction on an immediate note. Receiving a larger depreciation deduction in the current times leads to a business enjoying a reduction in its present tax bill.
Let’s understand this with the help of a simple example. If a newly bought electronic gadget is expected to have a life span of 15 years, 25 percent of its depreciable price could be deducted in its first year of use, compared to 10 percent for every consecutive year thereafter. The asset’s depreciable cost is also reduced every year by subtracting the depreciation cost from the previous year’s calculation.
Several different methods are used to work out the accelerated depreciation calculation on the asset subject to tax exemption. The two most frequently used rental property depreciation calculators include:
· Sum of the Years’ Digits (SYD):
Sum of the Years’ Digits Depreciation = Depreciable Cost x (Remaining Useful Life /
Sum of Years’ Digits)
· Double Declining Balance Method:
Double Declining Depreciation = 2 * Straight-Line Depreciation Rate * Value at
the beginning of the Year
What is the Straight Line Depreciation method?
It is by far the simplest method to calculate depreciation that basically involves a longer period of time to expense an asset than the time when it was purchased. It is calculated by simply dividing the difference between the cost of a property and the expected salvage amount by the number of years it is expected to be put into use.
This makes amortization and calculation simpler and easier to understand. Businesses and companies use amortization for certain select intangible assets such as patents and software along with depreciation in physical assets.
We may use both the conventions to expense an asset over a longer period of time that is not limited to merely the time of purchase. In other words, companies can stretch the cost of assets over numerous different time frames, which causes them significant benefit from the asset without deducting the full cost from the net income of the property. Straight Line Basis can be calculated quite easily using the following three variables:
Straight Line Basis = (Purchase Price of Asset – Salvage Value) / (Estimated
Useful Life of Asset)
Although it renders lesser errors over the life of the property and expenses the same value every accounting period, there is a marginal risk associated with the fact that technological advancements can unexpectedly render the property obsolete, leading to a considerable loss in the value of the concerned asset.
What is Bonus Depreciation and how is it calculated?
Bonus depreciation is the method allowing a business to make an extra deduction of 100% over the cost of certain property qualifying for it in the first year in which it is bought or rather put to usage. This special deduction allowance is an additional deduction one can enjoy after they take any Section 179 deduction and before one figure out regular depreciation for the current year.
Taking a very simple instance, supposing one purchase a $10,000 piece of machinery that they plan to use for ten years, rather than expense the full sum of $10,000 in the first year, one might expense off $1,000 per year for a tenure of ten years.
However, the eligibility criteria of property for bonus depreciation have a few strict requirements. The property must abide by the following:
- The taxpayer shouldn’t have utilized the property at any time before acquiring it completely by legal ownership. For instance, if the business leases a piece of equipment or estate before purchasing it, would not be able to claim bonus depreciation on the equipment or the asset in consideration.
- The taxpayer must not have acquired the property from a party officially or personally related to the investor.
- The taxpayer should not have acquired the property as part of a tax-free transaction between the two parties.
What impact does Depreciation on Real estate Investment have on taxes?
Investors of Rental property and assets prefer including depreciation costs in the list of expenses while filing their yearly taxes. They can easily benefit from a reduction in tax liability depending on the tax bracket the investor is involved in.
Finally, this percentage would be crucial in determining the number of tax benefits on real estate investments to be enjoyed by the investor. It extends to a wealth-building strategy for tackling investment losses but is not limited to allowing them to claim deductions during each of the years in use. The simplest tact is to spread out the purchase value of the asset over multiple years and enjoy large depreciation in tax deduction.