Depreciation of property

[Jeremy H.]

As a rental property owner I found there is something new to deduct which is not available from a owner occupied property..  which is depreciation of the rental property.

My understanding is that you get that years overall assessed value - land value as stated on the property tax bill (for that year?)  and divide by 27.5 .   Is this correct?        In CA the property tax bill is adjusted annually, so is this number different each year?  So if the building value is $200,000 I would be able to deduct $7272?   That's seems to make a big difference in the federal tax next year.

I have also learned the appliances and replaced items at the property can be depreciated as well.  I read the IRS page it was not so clear to me so I am still trying to learn.

There is also something about recapturing the capital gain from the depreciation you took if you sell the property.. can anyone give me an example?

[Logan Allec]

@Jeremy H.

Land/Building Split

In terms of the land/building split, yes, you can use the assessor's determination, but there are other reasonable methods that can be employed in determining the land/building split.  You can also carve out personal property (e.g., appliances) and land improvements (e.g., driveway) from the purchase price that can be depreciated over 5 and 15 years, respectively.

The land/building split does not change; once you have determined that Building of X and Land of Y was placed in service in a given year, those are the values you use for the initial purchase price throughout the period the property is held.

Depreciation Factor

Also, the depreciation amount on the building will be different than Purchase Price divided by 27.5 in the initial year and the final year.  This is because depreciation on buildings is calculated using the mid-month convention.

Depreciation Recapture

Here's an example.  Let's assume you're in the 35% tax bracket, and let's say on 6/1/13 you bought a rental property for $100,000, which includes the purchase price and various closing costs.  You determined that the land/building split was 20/80, so you have non-depreciable Land of $20,000 and depreciable Building of $80,000.  You choose to not segregate out personal property and land improvements.

Your 2013 depreciation on this property is $1,576 (remember, it is not merely $80,000/27.5 due to the mid-month convention mentioned earlier).  Your 2014 depreciation is $2,909.  Your 2015 depreciation is $1,818 because you sell the property in May for $150,000.

Your adjusted basis in the property is $100,000 - $6,303 = $93,697.  The difference between this $93,697 and the $150,000 is your gain of $56,303.  The gain attributable to the land will be taxed as capital gain at 15% (yay), and the gain attributable to the building will be taxed as Section 1231 gain which will in general be taxed at 15% (yay) *except* for the portion of the gain ($6,303) that is attributable to depreciation, which will be taxed at the 1250 gain rate of 25% (boo).  That's the bite of depreciation recapture.  You don't get the favorable capital gains tax treatment on the entire gain.  But, if you look on the bright side, you got depreciation deductions at 35% but only have to recapture the gain at 25%.

Amortization

Also, you did not ask about this, but you do amortize intangible assets associated with obtaining your mortgage over the life of the mortgage.

Feel free to reach out if you have any more questions.