Pleasanton, CA · Member since 2015 · 66 posts · 9 votes
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?
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.
Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
10y
I believe the best thing for you to do is talk to a CPA, they will explain all the deductions you are allowed to take, and its best you hire one, so that at tax time you are sure to have that all in place. but to somewhat answer your questions, what you paid for the house can be depreciated over 27.5 years ( if you add to the value of the asset, that can be depreciated ), your appliances you purchase can also be depreciated but for the lifetime of an appliance (10-12 years). there are a lot of tax laws that i would advice you to seek professional assistance on so that you do not end up doing something wrong.
Investor · West Chester, PA · Member since 2016 · 3 posts · 0 votes
10y
You especially need to talk to a CPA regarding depreciation recapture if and when you sell the property. It can get complicated. Also, recapture comes into play whether you took depreciation or not - recapture is based on "allowable" depreciation, not actual.
Pleasanton, CA · Member since 2015 · 66 posts · 9 votes
10y
Thanks I will talk to a CPA to help, in about one year from now.
I am just doing some research on how much I can deduct, and I found the county assessed the value at 70% building 30% land break down. So I have a cost basis using 70% of the purchase price of the property (+ closing cost).
As I said I am just trying to figure out roughly the tax situation, but this part seems like a big one to me (5 digit deduction on schedule E) so I wanted to know how it works and not just go to a CPA and have him tell me a number.
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.
Rental Property Investor · Gainesville, FL · Member since 2015 · 1k+ posts · 432 votes
10y
@Jeremy H. I don't think a CPA will mind talking to you to give you an education when it's likely you would use them for your business.
I'm not a CPA but in simplistic terms and from what can be read in the IRS Publication 529, the 27.5 you speak of is for residential property.
The market value you see from the city/county appraiser is their appraised value while this does differ from market value. In any case, if you take that amount and divide it by 27.5, you get to depreciate that same amount ever year. It does not change.
For example, you buy a property and the appraised value by the city/county evaluation is 100k. This does not include land as that is excluded from this equation. 100/27.5 = 3,636n is the depreciated amount used on your taxes for the life of 27.5 years or if you sell the property prior to that 27.5 years.
I gave the most basic example and this does not include adding to the cost basis of the house for things like capital ex in the 1st year the property was purchased.
You use the tax assessor information to determine the portion of your COST BASIS that applies to the depreciable assets. In your example, if the tax assessed value (which is not an appraised value) sets the value of the improvements (dwelling structure) at 100K and the value of the land at 25K, then 100K of the 125K total value of the property, or 80% of the property's assessed value is attributed to the dwelling structure. Use 80% of your adjusted cost basis to determine your basis for depreciation.
If you purchased the property for $150K and did not make any improvements, then multiply your purchase price by 80% to determine how much of your purchase price is attributed to the dwelling structure and attribute the remaining 20% to the land value. In this example, $120K is the depreciation basis for the dwelling structure, and $30K is the non-depreciable basis for the land.
You can divide $120K by 27.5 to approximate how much depreciation you will be able to claim for a full year of rental service. However, for the first and last years of rental service, you have to prorate the depreciation to the number of months of the year the property was in service. The IRS Pub on depreciation has tables that tell you exactly how to prorate for a partial year based on the month the property was placed in service or the month the property was taken out of service.
Yes, you are correct and I just short cut to the "what would be yearly" depreciation with the exception of the 1st and last year. I was lazy in the description and only wanted to point out that the amount is the same every year, with the exception of the 1st and last year. And I should have said that but I didn't want to get into the fine explanation you provided. This is why I acquiesced to the CPAs.
In my example I believe is the same as determining what the depreciable amount will be based on. If I only purchase the home and have no additional to add to the cost basis, I would look at separating the land portion from what the appraised value from the appraisers site as they represent it. This could be semantics since my local web site refers to it as the "assessed" or "just value" and not tax assessed. In essence, this is what the property appraised refers to as their assessed value, still it's the tax value. I've had long discussions with my local appraisers office on the terms and what and how they view things. The site actually breaks down and splits the value of land from building.
My concern is that the tax assessment might not reflect what was actually paid for the property. maybe it does in CA, but this forum has a national even international viewers. Even if the assessment reflects the actual market value, what if you got the property at a foreclosure discount? I don't think the IRS will let you depreciate $100K for a dwelling structure that cost you only $75K.
Yes there is a difference between assessed value and appraised value, it is not semantics. The tax assessor is not an appraiser. The tax assessor's opinion of the value of a property may be higher or lower than its actual market value. Furthermore, in some tax jurisdictions, the assessed value for property tax purposes might be updated only once every three to five years.
That is why I strongly suggest using the tax assessor's ratio of the depreciable asset to total proprety value multiplied by the actual purchase price to determine the depreciation basis.
