Depreciation for investment property is calculated based on the property’s useful life rating, which can be found on depreciation schedules provided by government tax authorities like the IRS in the US. Depreciation allows property investors to claim a tax advantage, but only the investment cost applicable to buildings can be depreciated, not the cost of the land. The MACRS system is used for most business depreciation, with straight-line depreciation being the only method allowed for residential rental properties and commercial buildings.
To calculate depreciation for investment property, it is important to know the useful life rating of that property. Depreciation is a measure of the decline in value of an asset over time due to use or deterioration. For tax purposes, the useful lives of assets can be found on depreciation schedules printed by government tax authorities. In the United States, this authority is the Internal Revenue Service (IRS).
Calculating the depreciation of investment properties allows for a tax advantage that the property investor can claim against their investment income. The actual amount that can be claimed will depend on the amount paid for the property, the type of property, and the depreciation method used. An investor cannot deduct the total cost of the property in the year of purchase. Since the property will be useful for several years and therefore will generate income over time, the cost will be spread over the same period of time.
In the United States, most business depreciation is calculated using the Modified Accelerated Cost Recovery System, also known as MACRS. The IRS provides information on the property’s salvage class and salvage period, or useful life, and allowable depreciation methods. Residential rental properties and commercial structures are two main depreciation classifications. Investment property depreciation periods for residential rental properties are 27.5 years, and the period for commercial buildings is 39 years.
Under the MACRS system, the only depreciation method that can be used for residential rental property or commercial buildings is straight-line depreciation. This means that the total allowable depreciation of investment property, or investment cost, will be divided equally over the taxable life of the asset. The basis or amount invested in the asset is the cost of the investment property plus settlement fees, such as summary fees, registration fees, and title insurance.
The property must be used in a business or income-generating activity to allow for depreciation. Because investment property depreciation is claimed each year, the asset’s basis or value decreases by the amount of annual depreciation allowed. This is true every year of the asset’s life, whether or not the taxpayer claims the full amount allowed.
When calculating depreciation for investment property, only the investment cost applicable to the buildings can be depreciated, and not the cost of the land on which the buildings stand. Land cannot be depreciated because it does not deplete or wear out like structures or other assets do. However, land preparation costs, such as landscaping, can be depreciated if they are associated with depreciable property and a life can be determined for them.
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