Depreciation, Purchase Price or Market Value?

[James Bird]

Hi, (first post) I'm closing on a single family rental in 4 days and I've been trying to find out if depreciation is based on present value or my offer price. Its a foreclosure, estimated worth (after rehab) 195k and I offered 86k. What number do I use to figure my depreciation?

Thanks in advance.

[Paul Caputo]

It's way more complex than your purchase price or estimated ARV, you'll end up somewhere in the middle because you're gonna fix the place up. Depreciation is an incentive to businesses to buy property in the form of a tax deduction tied to the actual value of the property. So no you can't use a higher number than what you actually paid. Even though it'll be worth more on the open market than what you put into it the IRS doesn't care about market value, they care about what you paid.

If you get it for $86K that's you're starting point. From here you need to remove the non-depreciable land value according to your tax assessment or appraisal to get your depreciable property value. Land value is usually about 20% but it varies. So just to make it easy say that $86K is really $16K land and $70K building. So your starting depreciable cost basis would be $70K. Then you fix the place up say you put $50K into rehabbing. You then have an adjusted depreciable cost basis of $120K: the initial basis plus the improvements. Does that make sense? 

Truthfully you're not gonna know what your adjusted cost basis is until AFTER you complete the rehab. You won't lose any depreciation while you're doing the rehab work since the rental isn't ready to use yet so don't worry about that. Once it's ready to be rented it's placed in service and that is when depreciation begins.