Property tax depreciation allows owners of commercial properties to write off the loss in value over time on their tax returns. The straight-line method is used to calculate depreciation over 27.5 years for residential buildings and 39 years for non-residential buildings. Land is not depreciable. Depreciation reduces the appraised value of the building, resulting in higher capital gains taxes when sold.
Property tax depreciation refers to the amount of value lost over time by a property owned for business purposes, such as a rental property or store. Owners of such properties can write off the depreciation of the building that houses the business to reduce their annual tax burden. When calculating property tax depreciation, the original cost of the building is depreciated using a straight-line method over a period of 27.5 years if the building is residential, such as an apartment complex, or 39 years if not residential, such as a shop. While this depreciation helps the investor on annual tax returns, it works against him or her when the property is sold because the building’s reduced value means higher capital gains taxes must be paid.
Depreciation occurs when a business asset experiences normal wear and tear over a period of time, thereby decreasing its value. The owner of a depreciated asset can then expense the depreciated amount on his tax return, thus offsetting the loss in value somewhat. Real estate falls into this category if it is used for commercial purposes, thus creating the concept of property tax depreciation.
It is important to note that land is not a depreciable asset, so the cost of the land is subtracted from the purchase price of the property to determine the cost of the building in question. How the building is used then determines the length of time the building depreciates. The depreciation is then calculated using the straight-line depreciation method, where annual depreciation is equal to the original cost of the building divided by the depreciation period.
For example, a building that houses a convenience store costs the owner $7,800 US Dollars (USD) to purchase. Since this is a non-residential building but is being used for commercial purposes, the US Internal Revenue Service (IRS) estimates the building’s lifespan at 39 years. Therefore, $7,800 USD is divided by 39, which means that the tax depreciation in this case is $200 USD each year. In other words, the value of the building in year two will drop to $7,600 USD, or $7,800 USD minus $200 USD, then drop to $7,400 USD in year three, and so on.
Rental property tax depreciation is calculated the same way, albeit with a 27-year term attached by the IRS. The depreciation amount each year is known as the depreciation expense and can be reversed on tax returns by the landlord. This also means that the appraised value of the building decreases each time a depreciation expense is required, so when the owner sells that property, he or she will make higher capital gains. Since this is the case, higher taxes would be payable upon receipt of those gains than if the building had not been depreciated.
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