Investing in rental property can be a lucrative avenue for generating income, but it also comes with complexities, particularly regarding tax implications. One of the main aspects landlords must understand is how depreciation works. In this article, we will explore whether it is possible to change the depreciation value of your rental property, the various factors that influence depreciation, and the implications on your taxes.
Depreciation is an accounting method that allows property owners to allocate the cost of their investment over its useful life. For residential rental properties, the IRS allows depreciation over a period of 27.5 years. This concept acknowledges that properties will experience wear and tear, reducing their value over time. Depreciation serves as a tax deduction, reducing the taxable income of the property owner.
When you own a rental property, you may deduct the annual depreciation from your taxable income, based on the value of the property and any improvements made. The IRS provides guidelines on how to calculate depreciation:
The short answer is no; you cannot retroactively change the depreciation value of your rental property. The IRS mandates that the depreciable value is based on the original cost basis or the FMV at the time of conversion to rental use. However, there are certain circumstances where adjustments can be made:
If you failed to claim depreciation in previous years, you might be eligible for catch-up depreciation. This allows you to amend your tax returns for the years you missed and claim the depreciation that was owed to you. However, you cannot change the original cost basis; you can only claim what you should have claimed in past years.
While you cannot change the original depreciation value, you can increase the depreciable basis by making improvements that add value to your property. These improvements must be capitalized and can be depreciated over their useful life. For example:
When you sell a rental property, you must account for depreciation recapture. This means that the IRS requires you to pay taxes on the gain attributable to the depreciation deductions you claimed while owning the property. The recaptured amount is taxed at a maximum rate of 25%.
Several factors can influence the depreciation value of your rental property:
The economic climate can affect property values. If property values decline, this can lead to economic depreciation, impacting future depreciation calculations.
As properties age, they may require repairs and maintenance, which can affect their value and the depreciation claimed. Regular maintenance can help mitigate depreciation.
Different types of properties have varying depreciation schedules. For example, commercial properties are depreciated over 39 years, while residential properties are at 27.5 years.
By understanding the rules and regulations surrounding depreciation, property owners can better navigate their financial responsibilities and optimize their rental property investments.