Calculating Depreciation on a Low-Priced Property

[Sammy Lyon]

Hi BP sleuths!

I wanted to share this tax question here, I was hoping my accountant could help but he didn’t seem to have much advice about this. I’ve got some choices to make about depreciation on a rental property, and would love to hear people’s thoughts.

The property is an SFR, closed mid-December 2018, I received a few hundred dollars in rental credits at closing. So only a little bit of income in 2018, a little prepaid interest and insurance, and only a few days for depreciation.

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Question 1. Which value would you use for depreciation?

Lender’s Appraisal

$45,000

appraisal was not split into building and land — if I used this number would I just approximate 25% land value ($11,250) / 75% building value? ($33,750)

County Tax Assessor “Market Values”

$38,100

split into $13,300 land value and $24,800 building value

taxes are re-assessed every 3 years, not tied to sale date

County Tax Assessor “Assessed Values”

$13,340

split into $4,660 land value and $8,680 building value

I’m not sure what this is

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Question 2. What are the consequences of taking the first year $25,000 bonus depreciation?

If I use the County Tax Assessor “Market Values” I would depreciate $24,800 over 27.5 years. If I take the $25,000 bonus depreciation I will have fully depreciated the property in the first month of ownership, and all future income would not benefit from depreciation. Or is it worth just getting the $25k depreciation up front? My tax rate is about 22% and my exit plan is to hold onto the property for at least 3 years and 1031 exchange it into something larger.

If I use the Lender’s Appraisal (and let’s say it’s $33,750 building value depreciated over 27.5 years) - would I calculate the straight line depreciation on $33,750 THEN take the $25,000 bonus, or calculate straight line after the bonus, or not take the bonus at all?

My hunch is that if the property values were higher there would not be a question whether to take the bonus, but fully depreciating the property in the first month of ownership has possibly different consequences. This was not something I had considered, and it’s unclear to me what the pros and cons of this situation are.

Thanks in advance for your comments and ideas!

[Eamonn McElroy]

@Sammy Lyon

"Question 1. Which value would you use for depreciation?"

You don't use the appraisal or the assessor market value for determining your basis.  Generally speaking your basis is what you paid for the property if purchased in an arms-length sale, plus acquisition costs.  You can use either the appraisal or county assessor's figures to split that purchase price between land and improvements.

"Question 2. What are the consequences of taking the first year $25,000 bonus depreciation?"

You would be preparing an incorrect tax tax and would have to pay a CPA to correct it later, as well as pay additional tax, penalties, and interest.

You cannot 100% bonus out the building....