Help Understanding Depreciation and Improvements

[Sean Britt]

I am trying to understand how depreciation is calculated with respect to improvements. 

Please correct me if I am wrong, but my understanding is lets say I have a property I purchased at 200k. Lets say 50k is the value of the land and 150k is the property. My basis is 150k. I can take the depreciation of this over the next 27.5 years.

Lets say I have spent 10k on a new HVAC and fixtures in year 1. This would jump my basis up to 160k.

Do I depreciate based off 150k first and then add the 10k to the new basis? Or do I take my depreciation based off the 160k?

150k/27.5 = 5454.54 

150k - 5454.54 (write this off) = 144546.46 + 10,000 = 154546 new basis 

OR

160k/27.5 = 5818

160k - 5818 (write this off) = 154182 new basis

The numbers are close, but I wanted to know if I was even in the ballpark of being correct on how this is handled and then wanted to know if there is a certain order of how the basis must be categorized, such as improvements at the end or beginning of the year.

Thanks for your help BP.

[Dave Toelkes]

@Sean Britt

I am assuming that you started a 27.5 year depreciation schedule for the dwelling stucture when you put the property into service.  Then after the property was in service as a rental, you completed your round of improvements.  In this scenario, your project became a new depreciable asset with a new 27.5 year depreciation schedule beginning on the date you put the improvement into service..  You depreciate the cost of your improvement separately from the dwelling structure and maintain the improvement as a separate asset on your depreciation schedule with its own depreciation timeline.  

If my assumption was not correct, in that you did not put the property into service and the improvements were done to make the property ready for service as a rental, then combine the basis for the dwelling structure with your improvement cost, and depreciate the adjusted basis for the dwelling structure over 27.5 years starting on the date you place the property into service.  

Five years from now, if you replace the roof on yoru rental property, the roof becomes a new asset depreciated over 27.5 years starting on the date the new roof was put into service.   For us long term buy and hold investors, it would not be unusual for one property's depreciation schedule to have as many  as 10 separate depreciable assets, each with its own depreciation schedule.  Just the kitchen appliances alone add 5 or 6 separate depreciable assets to my property's depreciation schedule as they are replaced.

One more point.  Once you establish a depreciation basis, it never changes.  You don't adjust it each year as depreciation is taken.  Your tax basis, however, is adjusted for depreciation taken but that only comes into play when you sell or 1031 exchange.

If you are using a personal income tax software package such as TurboTax, the software will maintain your depreciation schedule and keep each new depreciable asset on its own timeline.